SOLUTIONS TO PROBLEMS
PROBLEM 2-1CSTARBUCKS CORPORATION
Balance Sheet
October 3, 2004
Assets
Current assets
Cash and cash equivalents $299,128
Short-term investments 353,881
Accounts receivable 140,226
Inventories 422,663
Prepaid exp. and other cur. assets 134,997
Total current assets $1,350,895
Long-term investments 306,926
Property and equipment, net 1,551,416
Intangible assets 95,750
Other assets 85,561
Total assets $3,390,548
Liabilities and Stockholders’ Equity
Current liabilities
Accounts payable $ 199,346
Accrued exp. and other cur. liabilities 425,536
Unearned revenue-current 121,377
Total current liabilities $ 746,259
Long-term liabilities
Long-term debt 3,618
Other long-term liabilities 166,453
Total long-term liabilities 170,071
Total liabilities 916,330
Stockholders’ equity
Common stock 996,078
Retained earnings 1,478,140
Total stockholders’ equity 2,474,218
Total liabilities and stockholders’ equity $3,390,548
PROBLEM 2-2CGRAHAM CORPORATION
Income Statement
For the Year Ended December 31, 2007
Revenues
Service revenue $77,000
Expenses
Salaries expense $44,000
Depreciation expense 5,300
Insurance expense 3,900
Utilities expense 3,000
Repair expense 1,800
Total expenses 58,000
Net income $19,000
GRAHAM CORPORATION
Retained Earnings Statement
For the Year Ended December 31, 2007
Retained earnings, January 1 $26,000
Add: Net income 19,000
45,000
Less: Dividends 7,000
Retained earnings, December 31 $38,000
PROBLEM 2-2C (Continued)
GRAHAM CORPORATION
Balance Sheet
December 31, 2007
Assets
Current assets
Cash $20,700
Accounts receivable 8,850
Prepaid insurance 1,950
Total current assets $31,500
Property, plant, and equipment
Equipment 38,000
Less: Accumulated depreciation 12,400 25,600
Total assets $57,100
Liabilities and Stockholders’ Equity
Current liabilities
Accounts payable $2,400
Salaries payable 1,700
Total current liabilities $4,100
Stockholders’ equity
Common stock 15,000
Retained earnings 38,000
Total stockholders’ equity 53,000
Total liabilities and stockholders’ equity $57,100
PROBLEM 2-3C(a) BARNETTE ENTERPRISES
Income Statement
For the Year Ended September 30, 2007
Revenues $56,800
Expenses
Cost of good sold $22,000
Wages expense 15,600
Interest expense 3,400
Depreciation expense 2,900
Selling expenses 2,700
Income tax expense 2,550
Total expenses 49,150
Net income $ 7,650
BARNETTE ENTERPRISES
Retained Earnings Statement
For the Year Ended September 30, 2007
Retained earnings, October 1 $21,300
Add: Net income 7,650
28,950
Less: Dividends 1,800
Retained earnings, September 30 $27,150
PROBLEM 2-3C (Continued)
(b) BARNETTE ENTERPRISES
Balance Sheet
September 30, 2007
Assets
Current assets
Cash $ 2,600
Short-term investments 3,000
Accounts receivable 2,500
Inventories 4,800
Prepaid expenses 1,350
Total current assets $14,250
Property, plant, and equipment
Land. 16,000
Building, net of accumulated depreciation 37,000
Equipment, net of accumulated depreciation 14,000
Total property, plant, and equipment $67,000
Total assets. $81,250
Liabilities and Stockholders’ Equity
Current liabilities
Accounts payable $ 6,300
Current portion of long term debt 5,000
Wages payable 1,100
Income taxes payable 700
Total current liabilities $13,100
Long term debt 31,000
Total liabilities 44,100
Stockholders’ equity
Common stock 10,000
Retained earnings 27,150
Total stockholders’ equity 37,150
Total liabilities and stockholders’ equity $81,250
PROBLEM 2-4C(a) Spiderman Company appears to be more profitable.
Its net income for 2007 is $74,000 ($504,000 – $248,000 – $132,000 – $6,000 – $44,000). Its earnings per share is $1.85 ($74,000 ÷ 40,000 shares outstanding). Batman’s net income for 2007 is $29,000 ($269,000 – $130,000 – $80,000 – $12,000 – $18,000). Its earnings per share is $.97 ($29,000 ÷ 30,000 shares outstanding).
(b) Batman appears to be more liquid. Batman’s 2007 working capital of $102,000 ($146,000 – $44,000) is 34% higher than Spiderman’s working capital of $76,000 ($182,000 – $106,000). In addition, Batman’s 2007 current ratio of 3.3:1 ($146,000 ÷ $44,000) is almost double Spiderman’s current ratio of 1.7:1 ($182,000 ÷ $106,000).
(c) Batman appears to be slightly more solvent. Batman’s 2007 debt to total assets ratio of 52.2% ($131,000 ÷ $251,000)a is lower than Spiderman’s ratio of 54.9% ($147,000 ÷ $268,000)b. The lower the percentage of debt to total assets, the lower the risk that a company may be unable to pay its debts as they come due.
Another measure of solvency, free cash flow, also indicates that Batman is more solvent. Batman had $13,000 ($36,000 – $15,000 – $8,000) of free cash flow while Spiderman had only $5,000 ($43,000 – $28,000 – $10,000).
a$131,000 ($44,000 + $87,000) is Batman’s 2007 total liabilities.
$251,000 ($146,000 + $105,000) is Batman’s 2007 total assets.
b $147,000 ($106,000 + $41,000) is Spiderman’s 2007 total liabilities.
$268,000 ($182,000 + $86,000) is Spiderman’s 2007 total assets.
PROBLEM 2-5C(a) Working capital = $136,100 – $45,100 = $91,000.
(b) Current ratio = = 3.0:1.
(c) Free cash flow = $105,000 – $64,000 – $18,000 = $23,000
(d) Debt to total assets ratio = = 61.6%.
(e) Earnings per share = = $3.35.
PROBLEM 2-6C2006 / 2007
(a) / Earnings per share.
= $.75 / = $.82
(b) / Working capital.
($9,000 + $14,000 + $4,000) –
$23,000 = $4,000 / ($10,500 + $18,000 + $5,700) –
$25,000 = $9,200
(c) / Current ratio.
= 1.2:1 / = 1.4:1
(d) / Debt to total assets ratio.
= 69.4% / = 59.8%
(e) / Free cash flow.
$13,000 – $8,000 – $3,000
= $2,000 / $20,000 – $11,000 – $5,000
= $4,000
(f) Net income and earnings per share have increased indicating that the underlying profitability of the corporation has improved. The liquidity of the corporation as shown by the working capital and the current
ratio has also improved. Finally, the corporation improved its solvency by improving its debt to total assets ratio as well as free cash flow.
Ratio / Home Depot / Lowes
(All Dollars Are in Millions)
(a) / Working capital / $14,190 – $10,529 = $3,661 / $6,974 – $5,719 = $1,255
(b) / Current ratio / 1.3:1 ($14,190 ÷ $10,529) / 1.2:1 ($6,974 ÷ $5,719)
(c) / Debt to total assets ratio / 37.9% ($14,749 ÷ $38,907) / 45.6% ($9,674 ÷ $21,209)
(d) / Free cash flow / $6,904 – $3,948 – $719
= $2,237 / $3,033 – $2,927 – $116
= ($10)
(e) / Earnings per share / $2.27 = / $2.80 =
(f) The comparison of the two companies shows the following:
Liquidity—Home Depot’s current ratio of 1.3:1 is slightly better than Lowes’ 1.2:1 and Home Depot has significantly higher working capital than Lowes.
Solvency—Home Depot’s debt to total assets ratio is about 20% less than Lowes and its free cash flow is much larger.
Profitability—Lowes’ earnings per share is about 23% higher than Home Depot’s.
PROBLEM 2-8C(a) Financial reporting is the compilation and presentation of financial information for a company. It provides information in the form of financial statements and additional disclosures that is useful for decision making.
The accounting rules and practices that have substantial authoritative support and are recognized as a general guide for financial reporting purposes are referred to as generally accepted accounting principles (GAAP). The companies under consideration will follow GAAP to
report assets, liabilities, stockholders’ equity, revenues, and expenses in their financial statements.
(b) The members who plan to hold their investments until retirement will be most interested in long-term profitability and solvency. Those looking to supplement current income will be more interested in dividend paying capabilities.
Ratio analysis on an intracompany, industry-average, and intercompany basis will be easily accomplished for well established, publicly traded companies. Such analysis for a start up business may be
inadequate or even impossible.
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