(a) Condensed Income Statement
For the Year Ended December 31, 2002
AppaloosaCompany / Palamino
Company
Dollars / Percent / Dollars / Percent
Net sales
Cost of goods sold
Gross profit
Operating expenses
Income from operations
Other expenses and losses
Interest expense
Income before income taxes
Income tax expense
Net income / $250,000
160,000
90,000
51,000
39,000
3,000
36,000
11,000
$25,000 / 100.0%
64.0%
36.0%
20.4%
15.6%
1.2%
14.4%
4.4%
10.0% / $1,200,000
720,000
480,000
252,000
228,000
10,000
218,000
65,000
$ 153,000 / 100.0%
60.0%
40.0%
21.0%
19.0%
.8%
18.2%
5.4%
12.8%
(b) Palamino Company appears to be more profitable. It has higher relative
gross profit, income from operations, income before taxes, and net in-
come. Palamino’s return on assets of 10.6%, is higher than Appaloosa Company’s return on assets of 6.1%, . Also, Palamino’s return on stockholders’ equity of 15.1%, is higher than Appaloosa’s return on stockholders’ equity of 8.5%, .
PROBLEM 15-1B (Continued)
a$153,000 is Palamino’s 2002 net income. $1,450,000 is Palamino’s 2002 average assets:
2002 / 2001Current assets
Plant assets
Total assets / $ 700,000
800,000
$1,500,000 / + / $ 650,000
750,000
$1,400,000 / = /
b$25,000 is Appaloosa’s 2002 net income. $407,500 is Appaloosa’s 2002 average assets:
2002 / 2001Current assets
Plant assets
Total assets / $130,000
305,000
$435,000 / + / $110,000
270,000
$380,000 / = /
c$153,000 is Palamino’s 2002 net income. $1,012,500 is Palamino’s 2002 average stockholders’ equity:
2002 / 2001Common stock
Retained earnings
Stockholders’
equity / $ 750,000
300,000
$1,050,000 / + / $700,000
275,000
$975,000 / = /
d$25,000 is Appaloosa’s 2002 net income. $292,500 is Appaloosa’s 2002 average stockholders’ equity:
2002 / 2001Common stock
Retained earnings
Stockholders’
equity / $260,000
65,000
$325,000 / + / $210,000
50,000
$260,000 / = /
(a) Earnings per share = = $2.96.
(1) [15,000 – (1,000 ÷ 2)]
(b) Return on stockholders’ equity =
=
= 10.6%.
(c) Return on assets = = = 6.2%.
(d) Current ratio = = 1.5:1.
(e) Acid-test ratio = = 1.0:1.
(f) Receivables turnover =
=
= 6.6 times.
PROBLEM 15-2B (Continued)
(g) Inventory turnover = = = 6.5 times.
(h) Times interest earned = = 9.6 times.
(i) Asset turnover = = 1.0 times.
(j) Debt to total assets = = 41.5%.
(k) Current cash debt = = .23:1.
(l) Cash return on sales = = 5.5%.
(m) Cash debt coverage = = .13 times.
PROBLEM 15-3B(a) / 2001 / 2002
(1) / Profit margin.
= 9% / = 7%
(2) / Asset turnover.
= 1.2 times / = 1.0 times
(3) / Earnings per share.
= $1.97 / = $1.24
(4) / Price-earnings ratio.
= 2.3 times / = 1.9 times
(5) / Payout ratio.
* = 69.8%
*($105,000 + $63,000 – $124,000) / ** = 76.1%
**($124,000 + $46,000 – $135,000)
(6) / Debt to total assets.
= 24.4% / = 26.7%
PROBLEM 15-3B (Continued)
(b) The underlying profitability of the corporation has declined. For example, the profit margin and earnings per share have both declined. In addition, the corporation’s price-earnings ratio has decreased, which suggests that investors may be looking less favorably at the corporation. Also, the corporation appears to be increasing its debt burden as its debt to total assets has increased. Similarly, its payout ratio has increased, which should have an adverse effect on its solvency.
PROBLEM 15-4B(a) LIQUIDITY
2001 / 2002 / ChangeCurrent / = 2.1:1 / = 2.1:1 / No change
Acid-test / = .7:1 / = .7:1 / No change
Receivables
turnover / = 11.3 times / = 10.7 times / Decrease
Inventory
turnover / = 1.7 times / = 1.5 times / Decrease
A slight decrease in short-term liquidity exists.
PROFITABILITY
Profitmargin / = 9.6% / = 11.5% / Increase
Asset
turnover / = .8 times / = .8 times / No change
Return on
assets / = 7.5% / = 8.9% / Increase
Earnings
per share / = $.90 / = $1.15 / Increase
Overall profitability has improved.
PROBLEM 15-4B (Continued)
1. / Return on
common
stockhold-
ers’ equity / = 15.1% / = 12.1% / Decrease
2. / Debt
to total
assets / = 39.9% / = 27.3% / Decrease
3. / Price-
earnings
ratio / = 4.3 times / = 5.0 times / Increase
(a) ($500,000 + $305,000 + $500,000 + $220,000) ÷ 2.
(b) ($825,000* + $430,000** + $500,000 + $305,000) ÷ 2.
(c) $125,000 ÷ 100,000.
**$500,000 + (65,000 X $5/share)
**$305,000 + $125,000
PROBLEM 15-5B(a) / Ratio / Bethlehem Steel / Inland Steel
(All Dollars Are in Millions)
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
(10)
(11)
(12) / Current
Receivables turnover
Inventory turnover
Profit margin
Asset turnover
Return on assets
Return on common
stockholders’ equity
Debt to total assets
Times interest earned
Current cash debt
coverage
Cash return on sales
Cash debt coverage / 1.6:1 ($1,569 ÷ $1,011)
9.4 ($4,819 ÷ $511)
5.2 ($4,548 ÷ $868)
1.7 ($81 ÷ $4,819)
.8 ($4,819 ÷ $5,830)
1.4 ($81 ÷ $5,830)
8.7 ($81 ÷ $927)
80 ($4,626 ÷ $5,782)
3.1 ($141 ÷ $46)
.07:1 ($90 ÷ $1,210)
1.9 % ($90 ÷ $4,819)
.02 times ($90 ÷ $4,820) / 1.9:1 ($1,081 ÷ $565)
8.7 ($4,497 ÷ $515)
9.9 ($3,991 ÷ $403)
2.4 ($107 ÷ $4,497)
1.3 ($4,497 ÷ $3,395)
3.2 ($107 ÷ $3,395)
15.8 ($107 ÷ $678)
78.2 ($2,621 ÷ $3,353)
3.3 ($241 ÷ $72)
.30:1 ($160 ÷ $540)
3.6 % ($160 ÷ $4,497)
.27 times ($160 ÷ $2,595)
(b) The comparison of the two companies shows the following:
Liquidity—Inland Steel’s current ratio is 1.9:1 compared to Bethlehem Steel’s 1.6:1 and its inventory turnover rate is 9.9 times compared to Bethlehem’s 5.2 times. Bethlehem does have a slightly better receivables turnover rate (9.4 vs. 8.7). However, in sum, Inland Steel is more liquid than Bethlehem Steel.
Profitability—Inland Steel is more profitable than Bethlehem Steel. It
betters Bethlehem in each of the profitability ratios.
Solvency—Inland Steel is more solvent than Bethlehem Steel. It betters Bethlehem Steel in the solvency measures.
PROBLEM 15-6BTimes Interest Earned = 8 =
Interest Expense = = $105,000
Income Before Taxes = $840,000 – $105,000 = $735,000
Income Tax Expense = $735,000 – $372,000 = $363,000
Cash Return on Sales = 14% = .14 =
Net Sales = = $6,000,000
Gross Profit = $6,000,000 – $4,200,000 = $1,800,000
Operating Expenses = $1,800,000 – $840,000 = $960,000
Inventory Turnover = 4.2 =
Average Inventory = = $1,000,000
$1,000,000 =
Inventory (12/31/02) = $796,000
PROBLEM 15-6B (Continued)
Asset Turnover = 1.2 =
Average Assets = = $5,000,000
$5,000,000 =
Total Assets (12/31/02) = $5,031,022
Current Assets = $5,031,022 – $3,234,000 = $1,797,022
Accounts Receivable = $1,797,022 – $385,000 – $796,000 = $616,022
Total Liabilities and Stockholders’ Equity = Total Assets = $5,031,022
Total Liabilities = $5,031,022 – $2,100,000 – $280,000 = $2,651,022
Working Capital = $1,344,000 = $1,797,022 – Current Liabilities
Current Liabilities = $453,022
Long-term Liabilities = $2,651,022 – $453,022 = $2,198,000
BYP 15-1 FINANCIAL REPORTING PROBLEM(a) LANDS’ END, INC.
Trend Analysis of Net Sales and Net Income
For the Five Years Ended 2001
Base Period 1997—(000’s omitted)
2001 / 2000 / 1999 / 1998 / 1997(1) / Net sales
Trend / $1,354,974
121% / $1,319,823
118% / $1,371,375
123% / $1,263,629
113% / $1,118,743
100%
(2) / Net income
Trend / $34,637
68% / $48,034
94% / $31,185
61% / $64,150
126% / $50,952
100%
Between 1997 and 2001 Lands’ End’s net sales increased by 21% or about 5% per annum. Lands’ End’s net income increased by 26% between 1997 and 1998 but declined drastically in 1999 before rebounding in 2000 and then declining again in 2001.
(b) (000’s omitted)
(1) Profit Margin
2001:$34,637 ÷ $1,354,974 = 2.6%
2000:$48,034 ÷ $1,319,823 = 3.6%
(2) Asset Turnover
2001:$1,354,974 ÷ [($507,629 + $456,196) ÷ 2] = 2.81 times
2000:$1,319,823 ÷ [($456,196 + $455,919) ÷ 2] = 2.89 times
(3) Return on Assets
2001:$34,637 ÷ [($507,629 + $456,196) ÷ 2] = 7.2%
2000:$48,034 ÷ [($456,196 + $455,919) ÷ 2] = 10.5%
BYP 15-1 (Continued)
(4) Return on Common Stockholders’ Equity
2001:$34,657 ÷ [($314,188 + $296,207) ÷ 2] = 11.4%
2000:$48,034 ÷ [($296,207 + $242,503) ÷ 2] = 17.8%
(c) (000’s omitted)
(1) Debt to Total Assets
2001:($178,874 + $14,567) ÷ $507,629 = 38.1%
2000:($150,872 + $9,117) ÷ $456,196 = 35.1%
(2) Times Interest Earned
2001:($55,011 + $1,512) ÷ $1,512 = 37.4 times
2000:($76,244 + $1,890) ÷ $1,890 = 41.3 times
Although creditors are providing 38% of Lands’ End’s total assets, its long-term solvency is not in jeopardy. Lands’ End has the ability to pay the interest on its debt as indicated by the times interest earned of about 37.
(d) Substantial amounts of important information about a company are not in its financial statements. Events involving such things as industry changes, management changes, competitors’ actions, technological developments, governmental actions, and union activities are often crit-ical to the successful operation of a company. Financial reports in the media and publications of financial service firms (Standard & Poors, Dun & Bradstreet) will provide relevant information not usually found in the annual report.
Because of the 28% decline in earnings from 2000 to 2001, Lands’ End’s profitability ratios declined by nearly that same percentage. Yet, Lands’ End’s ratios are near the industry’s averages or slightly below.
BYP 15-2 COMPARATIVE ANALYSIS PROBLEM(a) / Lands’ End / Abercrombie & Fitch
(1) / (i) / Percentage increase
in net sales / = 2.7% / = 20%
(ii) / Percentage increase
(decrease) in net
income / = (27.8%) / = 5.7%
504.75
(2) / (i) / Percentage increase
(decrease) in total assets / = 11.3% / = 28.2%
(ii) / Percentage increase
(decrease) in total stockholders’ equity / = 6% / = 35.9%
(3) / Basic earnings per share / $1.15* / $1.58*
Price-earnings ratio / = 25.4 times / = 15.7 times
*Given on income statement
(b) Abercrombie & Fitch’s net sales increased 20% while Lands’ End’s increased 2.7%. However, Abercrombie & Fitch’s net income increased 5.7% while Lands’ End’s net income decreased 27.8% from 2000 to 2001. Abercrombie & Fitch’s total assets increased 28.2% while Lands’ End increased its assets 11.3%.
Abercrombie & Fitch increased stockholders’ equity by 35.9% while Lands’ End’s stockholders’ equity increased 6%. The absolute amounts
of earnings per share, $1.15 for Lands’ End and $1.58 for Abercrombie
& Fitch, are not comparable in a qualitative way since these amounts
are dependent on the number of shares outstanding.
Based on profitability (Abercrombie & Fitch increased net sales and net income while Lands’ End’s net income decreased), Abercrombie & Fitch had a much better year than did Lands’ End.
BYP 15-3 RESEARCH CASE1. (a) Common-size balance sheet:
Cash and Equivalents 0.1%
Trade Receivables (net) 2.1%
Inventory 42.9%
All Other Current 1.6%
Total Current 46.7%
Fixed Assets (net) 48.4%
Intangibles (net) 0.0%
All Other Noncurrent 4.9%
Notes Payable—S/T 5.5%
CMLTD 0.3%
Trade Payables 18.0%
I/T Payable 1.1%
All Other Current 5.5%
Total Current 30.4%
Long-Term Debt 29.6%
Deferred Taxes 1.3%
All Other Noncurrent 0.0%
Net Worth 38.8%
Common-size income statement:
Net Sales 100.0%
Gross Profit 21.4%
Operating Expenses 15.4%
Operating Profit 6.0%
All Other Expenses (net) 0.8%
Profit Before Taxes 5.2%
(b) Current Ratio = $15,338 ÷ $9,973 = 1.54
Quick Ratio = $745 ÷ $9,973 = 0.07
Sales/Receivables = $82,494 ÷ $700 = 117.85
Cost of Sales/Inventory = $65,586 ÷ $14,064 = 4.66
Cost of Sales/Payables = $65,586 ÷ $5,907 = 11.10
Sales/Working Capital = $82,494 ÷ ($15,338 – $9,973) = 15.38
EBIT/I = ($4,262 + $520 + $186) ÷ ($520 + $186) = 7.04
BYP 15-3 (Continued)
Net Profit + Depreciation + Amortization/CMLTD = ($2,681 + $1,070)
÷ ($23 + $64) = 43.11
Fixed/Worth = ($14,308 + $1,566) ÷ $12,726 = 1.25
Debt/Worth = ($9,973 + $7,871 + $1,838 + $411) ÷ $12,726 = 1.58
% Profit before Taxes/Net Worth = $4,262 ÷ $12,726 = 33.49%
% Profit before Taxes/Total Assets = $4,262 ÷ $32,819 = 12.99%
Sales/Net Fixed Assets = $82,494 ÷ ($14,308 + $1,566) = 5.20
Sales/Total Assets = $82,494 ÷ $32,819 = 2.51
% Depreciation and Amortization/Sales = $1,070 ÷ $82,494 = 1.3%
(c) Common-size balance sheet:On the asset side, Wal-Mart has low cash balance and significantly more fixed assets. Wal-Mart relies heavily on long-term debt.
Common-size income statement:Wal-Mart’s gross profit margin is relatively small, but low operating expenses boost pretax profit to
a higher percentage of sales.
Liquidity ratios:While the current ratio is in the middle of the third quartile, the low cash balance puts the quick ratio in the bottom quartile. The receivables turnover is slower than the median, but receivables are only 2.1% of total assets. Inventory turnover at the 75th percentile is good. A cost of sales/payable ratio above the median indicates that Wal-Mart has no problem paying its bills. The relatively high sales/working capital ratio indicates that working capital is being used efficiently.
Coverage ratios:Despite Wal-Mart’s greater reliance on debt financing, both its coverage ratios are above the median.
Leverage ratios:The fixed/worth ratio is extremely high, but the debt/worth measure is only slightly below the median.
Operating ratios:Both Wal-Mart’s pretax returns on net worth and assets are strong (near the 75th percentile). Sales/fixed assets is extremely low due to high investment in PP&E; however, the asset turnover is slightly above the median.
(d) 17
BYP 15-4 INTERPRETING FINANCIAL STATEMENTSCATERPILLAR CORP. VS. MANITOWOC COMPANY
(a) Liquidity can be determined with the following measures:
Caterpillar / Manitowoc1. / Current ratio / $7,647 ÷ $6,049 = 1.26:1 / $135,145 ÷ $110,923 = 1.22:1
2. / Acid-test ratio / = .81:1 / = .61:1
3. / Current cash
debt coverage / = .38:1 / = .20:1
The measures suggest that Caterpillar is more liquid than Manitowoc, but that both have relatively low liquidity measures. In particular, Manitowoc’s low current cash debt coverage ratio deserves further investigation.