EXERCISES
Exercise 13-1 (20 minutes)
2010 / 2009 / 2008 / 2007 / 2006Sales......
/ 189 / 181 / 168 / 156 / 100Cost of goods sold...... / 191 / 182 / 172 / 159 / 100
Accounts receivable...... / 201 / 192 / 182 / 169 / 100
Analysis: The trend in sales is positive. While this is better than no growth, one cannot definitively say whether the sales trend is favorable without additional information about the economic conditions in which this trend occurred such as inflation rates and competitors’ performances.
Given the trend in sales, the comparative trends in both cost of goods sold and accounts receivable are somewhat unfavorable. In particular, for the most recent year, both are increasing at slightly faster rates (indexes for cost of goods sold is 191 and accounts receivable is 201) compared to sales (index is 189).
Exercise 13-2 (25 minutes)
Answer: Net income decreased.
Supporting calculations: When the sum of each year's common-size cost of goods sold and total expenses is subtracted from the common-size sales percent, the net income percent is as follows:
2007 net income percent: 100.0 - 59.1 - 15.1 = 25.8% of sales
2008 net income percent: 100.0 - 61.9 - 14.8 = 23.3% of sales
2009 net income percent: 100.0 - 63.4 - 15.3 = 21.3% of sales
Next, notice that if 2007 sales are assumed to be $100, then sales for 2008 are $104.20 and the sales for 2009 are $105.40. If the net income percents for the three years are applied to these amounts, the net incomes are:
2007 net income: $100.00 x 25.8% = $25.80
2008 net income: $104.20 x 23.3% = $24.28
2009 net income: $105.40 x 21.3% = $22.45
This shows that net income decreased over the three-year period.
Exercise 13-3 (25 minutes)
2008 / 2007Sales......
/ 100.0% / 100.0%Cost of goods sold...... / 75.7 / 46.5
Gross profit...... / 24.3 / 53.5
Operating expenses...... / 17.3 / 35.0
Net income...... / 7.0% / 18.5%
Analysis: Overall, this company’s situation has worsened. This is evident from the substantial decline in net income as a percent of sales for 2008 (7.0%) relative to 2007 (18.5%). The main culprit is the increase in cost of goods sold as a percent of sales from 46.5% in 2007 to 75.7% in 2008. On a somewhat positive note, the company has not experienced any increase in operating expenses as a percent of sales; indeed, declining from 35.0% in 2007 to 17.3% in 2008. Even more positive is the company’s level of sales increase from $625,000 in 2007 to $740,000 in 2008.
Exercise 13-4 (30 minutes)
Parker has a greater amount of working capital. This by itself does not indicate whether the company is more capable of meeting its current obligations. However, support is provided by the current ratio and acid-test ratio, which show Parker is in a more liquid position than Morgan. This evidence does not mean that Morgan's liquidity is inadequate. Such a conclusion would require more information such as norms for the industry or its other competitors. Notably, Morgan's acid-test ratios approximate the traditional rule of thumb (1 to 1).
This evidence also shows that Parker's working capital, current ratio, and acid-test ratio all increased dramatically over the three-year period. This trend toward greater liquidity may be positive, but it can also suggest that Parker holds an excess amount of highly liquid assets that typically earn low returns.
The accounts receivable turnover and inventory turnover indicate that Morgan is more efficient in collecting its accounts receivable and in generating sales from available inventory. However, these statistics also may suggest that Morgan is too conservative in granting credit and investing in inventory. This could have a negative impact on sales and net income. Parker's ratios may be acceptable, but no definitive determination can be made without having information on industry (or other competitors’) standards.
Exercise 13-5 (30 minutes)
Comparative Analysis Report
Clay's profit margins are higher than Roak's. However, Roak has significantly higher total asset turnover ratios. As a result, Roak generates a substantially higher return on total assets.
The trends of both companies include evidence of growth in sales, total asset turnover, and return on total assets. However, Clay's rates of improvement are better than Roak's. These differences may result from the fact that Clay is only three years old, while Roak is a somewhat more established company. Clay's operations are considerably smaller than Roak's, but that will not persist many more years if both companies continue to grow at their current rates.
To some extent, Roak's higher total asset turnover ratios may result from the fact that its assets may have been purchased years earlier. If the turnover calculations had been based on current values, the differences might be less striking. The relative ages of the assets also may explain some of the difference in profit margins. Assuming Clay's assets are newer, they may require smaller maintenance expenses.
Finally, Roak successfully employed financial leverage in 2010. Its return on total assets is 9.0% compared to the 7% interest rate it paid to obtain financing from creditors. In contrast, Clay's return is only 5.9% as compared to the 7% interest rate paid to creditors.
Exercise 13-6 (20 minutes)
Simeon CompanyCommon-Size Comparative Balance Sheets
December 31, 2007-2009
At December 31 / 2009 / 2008* / 2007
Assets
Cash......
/ 6.1% / 8.0% / 10.0%Accounts receivable, net...... / 17.1 / 14.0 / 13.3
Merchandise inventory......
/ 21.5 / 18.5 / 14.3Prepaid expenses...... / 2.0 / 2.1 / 1.3
Plant assets, net ...... / 53.3 / 57.3 / 61.1
Total assets ...... / 100.0% / 100.0% / 100.0%
Liabilities and Equity
Accounts payable...... / 24.8% / 16.9% / 13.6%Long-term notes payable secured by
mortgages on plant assets ...... / 18.8 / 22.9 / 22.1
Common stock, $10 par value...... / 31.3 / 36.7 / 43.3
Retained earnings ...... / 25.1 / 23.5 / 21.0
Total liabilities and equity...... / 100.0% / 100.0% / 100.0%
* Column does not equal 100.0 due to rounding.
Analysis: Several observations can be made.
(1) Cash as a percent of assets has declined—this is favorable provided sufficient cash is available for operations.
(2) Accounts receivable have increased as a percent of assets—this may be unfavorable in that assets are tied up in an unproductive manner and there would be additional assets exposed to the risk of uncollection; it could be favorable if increased sales outweigh these costs and risk.
(3) Plant assets have declined as a percent of assets—this is favorable if the company is operating more efficiently; it could be unfavorable if the company is downsizing due to poor performance.
(4) Accounts payable have markedly increased as a percent of assets—this could reveal liquidity constraints.
Exercise 13-7 (25 minutes)
1.Current ratio
2009:= 1.88 to 1
2008:= 2.52 to 1
2007:= 2.87 to 1
2.Acid-test ratio
2009: = 0.93 to 1
2008: = 1.30 to 1
2007: = 1.72 to 1
Analysis and Interpretation: Simeon's short-term liquidity position has deteriorated over this three-year period. Both the current and acid-test ratios show declining trends. Although we do not have information about the nature of the company's business, the acid-test ratio shifts from ‘1.72 to 1’ down to ‘0.93 to 1’ and the current ratio shifts from ‘2.87 to 1’ down to ‘1.88 to 1’—both suggest a potential liquidity problem. Still, we must recognize that industry standards could show that the 2007 ratios were too high (instead of 2009 ratios as being too low).
Exercise 13-8 (25 minutes)
1.Days' sales uncollected
2009: x 365 = 48.5 days
2008: x 365 = 42.9 days
2.Accounts receivable turnover
2009: = 8.9 times
2008: = 9.4 times
3.Inventory turnover
2009: = 4.2 times
2008: = 5.1 times
4.Days’ sales in inventory
2009: x 365 = 99.9 days
2008: x 365 = 87.2 days
Analysis and Interpretation: The number of days' sales uncollected has increased and the accounts receivable turnover has declined. Also, the inventory turnover has decreased and days’ sales in inventory has increased. While none of these changes in ratios that occurred from 2008 to 2009 appear dramatic, it seems that Simeon is becoming less efficient in managing its inventory and in collecting its receivables.
Exercise 13-9 (25 minutes)
1.Debt and equity ratios
2009 / 2008Total liabilities and debt ratio
$129,900 + $98,500...... / $228,400 / 43.7%
$75,250 + $101,500...... / $176,750 / 39.7%
Total equity and equity ratio
$163,500 + $131,100...... / 294,600 / 56.3
$163,500 + $104,750...... / ______ / _____ / 268,250 / 60.3
Total liabilities and equity......
/ $523,000 / 100.0% / $445,000 / 100.0%2.Debt-to-equity ratio
2009: $228,400 / $294,600 = 0.78 to 1
2008: $176,750 / $268,250 = 0.66 to 1
3.Times interest earned
2009: ($31,100 + $9,525 + $12,100) / $12,100 = 4.4 times
2009: ($29,375 + $8,845 + $13,300) / $13,300 = 3.9 times
Analysis and Interpretation: Simeon added debt to its capital structure during 2009, with the result that the debt ratio increased from 39.7% to 43.7%. In addition, the debt-to-equity ratio also increased from 0.66 to 1to 0.78 to 1. We should note that the debt increase is mostly in current liabilities, which places a greater stress on short-term liquidity.
Exercise 13-10 (30 minutes)
1.Profit margin
2009: $31,100 / $673,500 = 4.6%
2008: $29,375 / $532,000 = 5.5%
2.Total asset turnover
2009: = 1.4 times
2008: = 1.3 times
3.Return on total assets
2009: = 6.4%
2008: = 7.1%
Analysis and Interpretation: Simeon's operating efficiency appears to be declining because the return on total assets decreased from 7.1% to 6.4%. While the total asset turnover favorably increased slightly from 2008 to 2009, the profit margin unfavorably decreased from 5.5% to 4.6%. The decline in profit margin indicates that Simeon's ability to generate net income from sales has declined.
Exercise 13-11 (20 minutes)
1.Return on common stockholders' equity
2009: = 11.1%
2008: = 11.5%
2.Price-earnings ratio, December 31
2009: $30 / $1.90 = 15.8
2008: $28 / $1.80 = 15.6
3.Dividend yield
2009: $0.29 / $30 = 0.1%
2008: $0.24 / $28 = 0.9%
Analysis and interpretation
- The company’s return on common stockholders’ equity is good, but not great. An 11% return makes it an acceptable investment provided its risk is not too high.
- The company’s price-earnings ratio is around 16. This suggests that the market does view this company to have some growth potential.
- The dividend yield is on the low side. Thus, this stock would likely be classified as a “growth” stock, and the price-earnings ratio suggests that the market does perceive a high likelihood of some growth.
Exercise 13-12A (10 minutes)
1.AIncome (loss) from continuing operations
2.CExtraordinary gain (loss)
3.AIncome (loss) from continuing operations
4.AIncome (loss) from continuing operations
5.AIncome (loss) from continuing operations
6.BGain (loss) from disposing of a discontinued segment
7.BIncome (loss) from operating a discontinued segment
8AIncome (loss) from continuing operations
Exercise 13-13 (15 minutes)
randa merchandisING, INC.Income Statement
For Year Ended December 31, 2008
Net sales...... / $2,900,000
Expenses
Cost of goods sold...... / $1,480,000
Salaries expense...... / 640,000
Depreciation expense...... / 232,500
Total expenses...... / 2,352,500
Income from continuing operations before taxes... / 547,500
Income taxes expense...... / 217,000
Income from continuing operations...... / 330,500
Discontinued segment
Loss from operating wholesale business segment (net of tax) /
(444,000)
Gain on sale of wholesale business
segment (net of tax)...... /
775,000 /
331,000
Income before extraordinary gain...... / 661,500
Extraordinary gain on condemnation of
company property (net of tax)...... /
230,000
Net income...... / $ 891,500
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©McGraw-Hill Companies, 2008
Solutions Manual, Chapter 13