chapter 15 financial statement analysis study … statement analysis study guide solutions 1 ......

Chapter 15

Financial Statement Analysis

Study Guide Solutions

1 ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to publicly accessible website, in whole or in part.

Fill-in-the-Blank Equations

1. Working capital

2. Current ratio

3. Quick assets

4. Sales

5. Average daily sales

6. Cost of goods sold

7. Average daily cost of goods sold

8. Fixed assets (net)

9. Ratio of liabilities to stockholders’ equity

10. Income before income tax

11. Net income

12. Average total assets

13. Interest expense

14. Income from operations

15. Net income

16. Preferred dividends

17. Earnings per share on common stock

18. Earnings per share on common stock

19. Dividends per share

20. Dividend yield

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©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to publicly accessible website, in whole or in part.

Exercises 1. Perform a horizontal analysis on Tortoise Cleaning Corporation’s 2015 and 2016 balance

sheets. Round percentages to one decimal place.

Tortoise Cleaning Corporation Comparative Balance Sheet

December 31, 2016 and 2015 Increase (Decrease)

Assets Dec. 31, 2016 Dec. 31, 2015 Amount Percent Current assets $ 500,200 $ 480,300 $ 19,900 4.1%Long-term investments 1,200,450 1,540,600 (340,150) –22.1%Property, plant, and equipment (net) 9,750,000 8,890,000 860,000 9.7%Intangible assets 1,685,000 1,790,000 (105,000) –5.9%Total assets $13,135,650 $12,700,900 $ 434,750 3.4%

Liabilities Current liabilities $ 700,100 $ 654,300 $ 45,800 7.0%Long-term liabilities 7,685,000 7,750,300 (65,300) –0.8%Total liabilities $8,385,100 $8,404,600 $(19,500) –0.2%

Stockholders' Equity Preferred 4% stock, $10 par $ 877,600 $ 875,600 2,000 0.2%Common stock, $4 par 2,450,000 2,190,000 260,000 11.9%Retained earnings 1,422,950 1,230,700 192,250 15.6%Total stockholders' equity $ 4,750,550 $ 4,296,300 $454,250 10.6%Total liabilities and stockholders' equity $13,135,650 $12,700,900 $434,750 3.4%

Financial Statement Analysis 3


2. Using the 2015 and 2016 balance sheets in Exercise 1, prepare a vertical analysis. Round percentages to one decimal place.

Tortoise Cleaning Corporation Comparative Balance Sheet

December 31, 2016 and 2015 Dec. 31, 2016 Dec. 31, 2015

Assets Amount Percent Amount Percent Current assets $ 500,200 3.8% $ 480,300 3.8%Long-term investments 1,200,450 9.1% 1,540,600 12.1%Property, plant, and equipment (net) 9,750,000 74.2% 8,890,000 70.0%Intangible assets 1,685,000 12.8% 1,790,000 14.1%Total assets $13,135,650 99.9% $12,700,900 100.0%

Liabilities Current liabilities $ 700,100 5.3% $ 654,300 5.2%Long-term liabilities 7,685,000 58.5% 7,750,300 61.0%Total liabilities $8,385,100 63.8% $8,404,600 66.2%

Stockholders' Equity Preferred 4% stock, $10 par $877,600 6.7% $875,600 6.9%Common stock, $4 par 2,450,000 18.7% 2,190,000 17.2%Retained earnings 1,422,950 10.8% 1,230,700 9.7%Total stockholders' equity $ 4,750,550 36.2% $ 4,296,300 33.8%Total liabilities and stockholders' equity $13,135,650 100.0% $12,700,900 100.0%

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3. Using the 2015 and 2016 Income Statements shown, prepare a horizontal analysis, giving changes in amounts and percentages. Round percentages to one decimal place.

Tortoise Cleaning Corporation Comparative Income Statement

December 31, 2016 and 2015 Increase (Decrease)

Dec. 31, 2016 Dec. 31, 2015 Amount Percent Sales $386,050 $344,800 $ 41,250 12.0%Cost of goods sold 159,600 120,000 39,600 33.0%Gross profit $226,450 $224,800 $ 1,650 0.7%Selling expenses $ 25,790 $ 15,670 $ 10,120 64.6%Administrative expenses 22,980 12,600 10,380 82.4%Total operating expenses $ 48,770 $ 28,270 $ 20,500 72.5%Income from operations $177,680 $196,530 $(18,850) –9.6%Other income 6,100 9,500 (3,400) –35.8% $183,780 $206,030 $(22,250) –10.8%Other expenses 2,250 1,750 500 28.6%Income before income tax $181,530 $204,280 $(22,750) –11.1%Income tax expense 72,612 81,712 (9,100) –11.1%Net income $108,918 $122,568 $(13,650) –11.1%

4. Prepare a vertical analysis on the income statements from Exercise 3. Round percentages to one decimal place.

Tortoise Cleaning Corporation Comparative Income Statement

December 31, 2016 and 2015 Dec. 31, 2016 Dec. 31, 2015

Amount Percent Amount Percent Sales $386,050 100.0% $344,800 100.0% Cost of goods sold 159,600 41.3% 120,000 34.8% Gross profit $226,450 58.7% $224,800 65.2% Selling expenses $ 25,790 6.7% $ 15,670 4.5% Administrative expenses 22,980 6.0% 12,600 3.7% Total operating expenses $ 48,770 12.6% $ 28,270 8.2% Income from operations $177,680 46.0% $196,530 57.0% Other income 6,100 1.6% 9,500 2.8% $183,780 47.6% $206,030 59.8% Other expenses 2,250 0.6% 1,750 0.5% Income before income tax $181,530 47.0% $204,280 59.3% Income tax expense 72,612 18.8% 81,712 23.7% Net income $108,918 28.2% $122,568 35.6%



5. Perform a horizontal analysis on the 2015 and 2016 retained earnings statements given. What is the amount and percentage of increase or decrease? Round percentages to one decimal place.

Allen Ales Comparative Retained Earnings Statement

For the Years Ended December 31, 2016 and 2015 Increase (Decrease)

2016 2015 Amount Percent Retained earnings, January 1 $149,790 $145,790 $ 4,000 2.7% Net income for the year 28,790 22,300 6,490 29.1% Total $178,580 $168,090 $10,490 6.2% Dividends On preferred stock $ 8,500 $ 7,500 $ 1,000 13.3% On common stock 15,650 10,800 4,850 44.9% Total $ 24,150 $ 18,300 $ 5,850 32.0% Retained earnings, December 31 $154,430 $149,790 $ 4,640 3.1%

Strategy: For a horizontal analysis, first determine the amount of the change in amounts between the two years. The percentage change is found by taking the amount change and dividing it by the base year’s balance. Favorable changes include increases in income and assets and decreases in liabilities or expenses. An unfavorable change could be an increase in liabilities or expenses or a decrease in assets or income.

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6. Use a vertical analysis to identify increases or decreases in percentages for the income statements shown. Round percentages to one decimal place.

Greenwood Paper Supply Comparative Income Statements

For the Years Ended December 31, 2015 and 2016 Dec. 31, 2016 Dec. 31, 2015

Amount Percent Amount Percent Sales $287,400 100.0% $279,900 100.0% Cost of goods sold 87,500 30.4% 89,500 32.0% Gross profit $199,900 69.6% $190,400 68.0% Selling expenses $ 19,600 6.8% $ 15,850 5.7% Administrative expenses 21,000 7.3% 21,350 7.6% Total operating expenses $ 40,600 14.1% $ 37,200 13.3% Income from operations $159,300 55.5% $153,200 54.7% Other income 10,220 3.6% 9,750 3.5%

$169,520 59.1% $162,950 58.2% Other expenses 11,390 4.0% 10,400 3.7% Income before income tax $158,130 55.1% $152,550 54.5% Income tax expense 63,252 22.0% 61,020 21.8% Net income $ 94,878 33.1% $ 91,530 32.7%

Strategy: When preparing a vertical analysis on an income statement, percentages should be calculated as a percentage of sales. A vertical analysis identifies where the income is being generated and being used. The company should work toward decreasing the expenses as a percentage of sales and increasing net income as a percentage of sales. In a vertical analysis on a balance sheet, asset accounts should be calculated as a percentage of total assets and liability and stockholders’ equity accounts should be calculated as a percentage of total liabilities and stockholders’ equity (which is also equal to total assets). Since a change in one account will cause a change elsewhere on the balance sheet, the vertical analysis identifies where the changes occur.



7. Use the common-sized income statements that compare Greenwood Paper Supply to the industry average to identify expenses that the company should work toward decreasing.

Greenwood Paper Supply

Industry Average

Sales 100.0% 100.0% Cost of goods sold 45.2% 46.7% Gross profit 54.8% 53.3% Selling expenses 16.7% 12.9% Administrative expenses 14.5% 13.1% Total operating expenses 31.2% 26.0% Income from operations 23.6% 27.3% Other income 1.2% 1.8%

24.8% 29.1% Other expenses 0.9% 1.0% Income before income tax 23.9% 28.1% Income tax expense 8.4% 9.8% Net income 15.5% 18.3%

Greenwood Paper Supply should work toward decreasing its administrative and selling expenses. The company also has a high sales returns and allowances compared to the industry, so the company may need to find ways to decrease the number of sales returns.

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8. With the common-sized income statements shown that compare Small Supply to the industry average, identify weaknesses the company has.

Small Supply

Industry Average

Sales 100.0% 100.0% Cost of goods sold 34.8% 31.2% Gross profit 65.2% 68.8% Selling expenses 13.7% 13.9% Administrative expenses 12.1% 11.8% Total operating expenses 25.8% 25.7% Income from operations 39.4% 43.1% Other income 2.4% 1.9%

41.8% 45.0% Other expenses (interest) 1.5% 1.1% Income before income tax 40.3% 43.9% Income tax expense 14.1% 15.4% Net income 26.2% 28.5%

Small Supply has a higher cost of goods sold and administrative expenses, which could demonstrate inefficiencies. The company’s interest expense is also higher than the industry average, which shows that Small Supply finances with more long-term debt than others in its industry, making the company more risky to creditors.



9. Use the common-sized income statements, which compare Quiet Pints to the industry average, to identify unfavorable trends the company should work toward improving.

Quiet Pints Industry Average

Sales 100% 100% Cost of goods sold 46.5% 42.6% Gross profit 53.5% 57.4% Selling expenses 10.7% 9.5% Administrative expenses 13.4% 12.8% Total operating expenses 24.1% 22.3% Income from operations 29.4% 35.1% Other income 2.6% 2.7%

32.0% 37.8% Other expenses 1.1% 1.3% Income before income tax 30.9% 36.5% Income tax expense 10.8% 12.8% Net income 20.1% 23.7%

Quiet Pints has a higher cost of goods sold, selling expenses, and administrative expenses, which all indicate unfavorable trends. Strategy: A common-sized income statement shows the various income and expense items as a percentage of sales. If a company has a higher income line item (or a lower expense line item) as a percentage of its sales than its comparison (industry average, previous year, or competitor), the difference is favorable. For example, lower expenses as a percentage of sales indicate the company is spending less to generate the dollar in sales than its comparison. However, if the company has a lower percentage of an income line item (or a higher percentage of an expense line item) of its sales than its comparison, the difference is unfavorable. For example, higher expenses as a percentage of sales indicates that the company is spending more to generate each dollar of sales than its comparison.

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10. Perform a current position analysis by calculating the working capital, current ratio, and quick ratio on the following company for 2015 and 2016 to determine if its ability to pay current liabilities has improved or gotten worse. Round ratios to two decimal places.

2016 2015 Current assets $195,000 $140,600 Quick assets 125,000 100,200 Current liabilities 196,100 145,600 Working capital (1,100) (5,000)Current ratio 0.99 0.97Quick ratio 0.64 0.69

The increase in working capital and current ratio indicate that the company is better able to pay its current liabilities. However, because the quick ratio decreased, the company is less able to pay current liabilities without having to sell inventory or acquire cash.

11. Use the information below to calculate the working capital, current ratio, and quick ratio for 2015 and 2016. Has the corporation’s position to pay current liabilities improved or gotten worse? Round ratios to two decimal places.

2016 2015 Cash and cash equivalents $ 24,500 $ 22,650Accounts receivable 129,800 135,000Inventories 215,350 209,000Total current assets $369,650 $366,650Current liabilities 346,100 345,200Working capital 23,550 21,450Current ratio 1.07 1.06Quick ratio 0.45 0.46 ($369,650 – $215,350)/$346,100 ($366,650 – $209,000)/$345,200

Since working capital and current ratio improved, the company is in a better position to pay its current liabilities. However, because current assets consist mainly of inventory, the company would need to sell the inventory (more in 2016 than in 2015) to pay the current liabilities.



12. Calculate the working capital, current ratio, and quick ratio for 2015 and 2016 with the following information. Determine if the company is in a better position or worse position to pay its current liabilities. Round ratios to two decimal places.

2016 2015 Cash and cash equivalents $110,650 $100,750Temporary investments 50,300 68,900Accounts receivable 180,100 177,750Inventories 110,320 100,100Total current assets $451,370 $447,500Current liabilities 357,000 346,200Working capital 94,370 101,300Current ratio 1.26 1.29Quick ratio 0.96 1.00 ($451,370 – $110,320)/$357,000 ($447,500 – $100,100)/$346,200

The working capital, current ratio, and quick ratios decreased in 2016, showing that the company does not have the funds available to pay its current liabilities. The quick ratio for 2016 is less than one, which means the company will now have to sell inventory in order to pay its current liabilities. Strategy: Working capital gives the difference between the current assets and current liabilities. A positive working capital demonstrates the company’s ability to pay its current liabilities at the time, with excess current assets. Current ratio gives the number of times that a company can pay its current liabilities in the upcoming operating cycle. Companies prefer to maintain a current ratio above one to ensure their ability to pay their current liabilities using funds currently held and expected to receive in the upcoming operating cycle. The quick ratio gives the number of times a company can pay current liabilities using only funds that are easily obtainable, such as cash and cash equivalents and accounts receivable (which can be sold to third parties at a discount). Inventory is not considered a quick asset because it may be difficult to sell. To ensure its ability to pay current liabilities at the time, companies also usually prefer the quick ratio to be above one.

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13. Perform an accounts receivable analysis on the following company for 2015 and 2016 to determine if the company has improved its efficiency in collecting receivables. Round ratios (accounts receivable turnover and number of days’ sales in receivables) to two decimal places.

2016 2015 Sales $275,300 $220,500 Accounts receivable: Beginning of year 97,600 87,500 End of year 108,750 97,600 Average accounts receivable 103,175 92,550 Average daily sales 754 604 Accounts receivable turnover 2.67 2.38 ($275,300/$103,175) ($220,500/$92,550) Number of days' sales in receivables 136.84 153.23 ($103,175/$754) ($92,550/$604)

The decrease in number of days’ sales in receivables and increase in accounts receivable turnover indicates an improvement in collecting accounts receivable.

14. Using the accounts receivable turnover and number of days’ sales in receivables, determine if the company has decreased its risk of possible uncollectible accounts in 2016. Round ratios to two decimal places.


The decrease in accounts receivable turnover and increase in number of days’ sales in receivables indicate the company has increased its risk of uncollectible accounts because cash is not collected as efficiently for sales made on account.



15. A new manager at WFU Corporation has implemented new policies for all sales made on credit in hopes to improve efficiency in collecting receivables. With an accounts receivable analysis, determine if the manager’s strategies are helping to improve efficiency. Round ratios to two decimal places.


Since the accounts receivable turnover increased and the number of days’ sales in receivables decreased, the new strategies are working to improve efficiency, although not by a large amount. Strategy: Accounts receivable turnover gives how many times the company can collect all of its outstanding accounts receivable. The higher the ratio, the more number of times that a company actually collects its sales made on account. The number of days’ sales in receivables gives the average number of days a company takes to collect the cash after a sale. A lower number of days’ sales in receivables is desired because it shows that the company collects the cash from the customer quickly, rather than having large amounts of receivables outstanding for a long period of time.

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16. Perform an inventory analysis on the following company for 2015 and 2016 to determine if the company is improving its inventory management. Round ratios (inventory turnover and number of days’ sales in inventory) to two decimal places.

2016 2015 Cost of goods sold $117,600 $112,500 Inventory: Beginning of year 98,700 95,500 End of year 100,520 98,700 Average inventory 99,610 97,100 Average daily cost of goods sold 322 308 Inventory turnover 1.18 1.16 ($117,600/$99,610) ($112,500/$97,100) Number of days' sales in inventory 309.35 315.26 ($99,610/$322) ($97,100/$308)

Since the inventory turnover increased and the number of days’ sales in inventory decreased, the company has improved its inventory management.



17. Due to a recent increase in storage costs, a company is making an attempt to improve its inventory management. Calculate cost of goods sold for the years given and prepare an inventory analysis for 2015 and 2016; determine if the company has been successful. Round ratios to two decimal places.

2016 2015 Inventory: Beginning of year $215,100 $209,600 End of year 207,900 215,100 Purchases of inventory 200,500 239,675 Cost of goods sold 207,700 234,175 Average inventory 211,500 212,350 Average daily cost of goods sold 569 642 Inventory turnover 0.98 1.10 ($207,700/$211,500) ($234,175/$212,350) Number of days' sales in inventory 371.70 330.76 ($211,500/$569) ($212,350/$642)

Inventory

209,600 239,675 2015 CoGS

215,100 200,500 2016 CoGS 207,900

Since the inventory turnover decreased and the number of days’ sales in inventory increased, the company is unsuccessful in improving its effectiveness of inventory management.

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18. Farrell’s Window Supply has seen an increase in sales, but the company is concerned with its inventory management. Has the increase in sales caused the company’s ability to manage inventory effectively to decrease? Support your answer by finding the changes in inventory turnover and number of days’ sales in inventory. Round ratios to two decimal places.

2016 2015 Inventory: Beginning of year $350,900 $352,300 End of year 325,400 350,900 Purchases of inventory 330,600 325,200 Cost of goods sold 356,100 326,600 Average inventory 338,150 351,600 Average daily cost of goods sold 976 895 Inventory turnover 1.05 0.93 ($356,100/$338,150) ($326,600/$351,600) Number of days' sales in inventory 346.47 392.85 ($338,150/$976) ($351,600/$895)

Inventory

352,300 325,200 2015 CoGS

350,900 330,600 2016 CoGS 325,400

The company’s inventory management has improved, which is shown by a decrease in number of days’ sales in inventory and an increase in inventory turnover. Strategy: Number of days’ sales in inventory shows the number of days the company owns the inventory before actually selling the products to customers, so a smaller ratio indicates better inventory management because the managers are being more efficient at ordering products when needed. Inventory turnover gives the number of times during the year the company is able to sell all inventory on hand. A higher number indicates that the company is not purchasing more inventory than it can actually sell to customers.



19. Using the ratio of fixed assets to long-term liabilities and ratio of liabilities to stockholders’ equity for 2015 and 2016, determine which year the company’s creditors have a larger margin of safety. Round ratios to two decimal places.

2016 2015Fixed assets (net) $29,750 $22,300Current liabilities 9,770 10,500Long-term liabilities 56,500 51,000Total liabilities 66,270 61,500Total stockholder's equity 38,900 35,750Ratio of fixed assets to long-term liabilities 0.53 0.44 ($29,750/$56,500) ($22,300/$51,000)Ratio of liabilities to stockholders' equity 1.70 1.72 ($66,270/$38,900) ($61,500/$35,750)

Since the company has a higher ratio of liabilities to stockholders’ equity in 2015, the company’s creditors have a higher margin of safety in 2015. However, the higher ratio of fixed assets to long-term liabilities indicates that the creditors have a higher possibility of payment using fixed assets if the company defaults.

20. With the information below, calculate the ratio of fixed assets to long-term liabilities and ratio of liabilities to stockholders’ equity for 2015 and 2016. Are the changes favorable or unfavorable? Round ratios to two decimal places.

2016 2015 Current assets $18,750 $19,290 Fixed assets 106,150 106,310 Total assets 124,900 125,600 Current liabilities 15,470 17,600 Long-term liabilities 70,600 75,600 Total liabilities 86,070 93,200 Total stockholder's equity 38,830 32,400 Ratio of fixed assets to long-term liabilities 1.50 1.41 ($106,150/$70,600) ($106,310/$75,600) Ratio of liabilities to stockholders' equity 2.22 2.88 ($86,070/$38,830) ($93,200/$32,400)

The decrease in the ratio of liabilities to stockholders’ equity is favorable because the creditors have a higher margin of safety. The increase in ratio of fixed assets to long-term liabilities is also favorable because the company has more assets that it could sell to pay creditors, if needed.

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21. Determine if the company is in a better position to pay its creditors in 2015 or 2016 using the ratio of fixed assets to long-term liabilities and ratio of liabilities to stockholders’ equity using the information shown. Round ratios to two decimal places.

2016 2015 Current assets $46,790 $45,000Fixed assets 182,810 175,500Total assets 229,600 220,500Current liabilities 42,500 43,100Long-term liabilities 103,500 98,500Total liabilities 146,000 141,600Total stockholders’ equity 83,600 78,900Ratio of fixed assets to long-term liabilities 1.77 1.78 ($182,810/$103,500) ($175,500/$98,500)Ratio of liabilities to stockholders' equity 1.75 1.79 ($146,600/$83,600) ($141,600/$78,900) The decrease in ratio of fixed assets to long-term liabilities indicates the creditors have a smaller possibility of being paid because there are less assets held than liabilities. The decrease in liabilities to stockholders’ equity indicates that the company is in a better position to pay its creditors in 2016. Strategy: The ratio of fixed assets to long-term liabilities gives the dollar of fixed assets held per dollar of long-term liabilities outstanding. Creditors prefer higher ratios of fixed assets to long-term liabilities, which would indicate that the company has a higher ability to pay the creditors since it has assets it could sell. The ratio of liabilities to stockholders’ equity gives the amount of debt and equity financing. Creditors prefer a lower ratio of debt to stockholders’ equity, which indicates that the company will have lower interest to pay and principal to repay to other creditors.



22. Use the information shown to calculate the number of times interest charges and preferred dividends are earned for 2015 and 2016. Round answers to two decimal places. Is the change favorable or unfavorable?

2016 2015 Interest expense $3,500 $3,100Income before income tax 20,100 18,700Net income 13,065 12,155Preferred dividends 5,000 5,000Number of times interest charges are earned 6.74 7.03 ($20,100 + $3,500)/$3,500 ($18,700 +$3,100)/$3,100Number of times preferred dividends are earned 2.61 2.43 ($13,065/$5,000) ($12,155/$5,000)

The decrease in number of interest charges are earned is unfavorable for creditors, but the increase in number of times preferred dividends are earned is favorable for preferred stockholders.

23. Determine the number of times interest charges and preferred dividends are earned for 2015 and 2016 with the information shown. Assume that the company has a 40% tax rate. Round answers to two decimal places. In which year does the company have a stronger ability to pay creditors and preferred stockholders?

2016 2015 Interest expense $29,900 $27,650 Income before income tax 85,650 80,100 Net income 51,390 48,060 10% Preferred stock outstanding, $5 par 975,000 980,000 Preferred dividends 19,500 19,600 Number of times interest charges are earned 3.86 3.90 ($85,650 + $29,900)/$29,900 ($80,100 + $27,650)/$27,650 Number of times preferred dividends are earned 2.64 2.45 ($51,390/$19,500) ($48,060/$19,600)

The company has a better ability to pay creditors in 2015 but a better ability to pay preferred stockholders in 2016.

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24. Greenwood’s Paper Supply expects earnings to decrease in the upcoming year. The CEO would like to ensure creditors and preferred stockholders that interest and preferred dividends will still be paid as usual. Use the information below to calculate the number of times interest charges and preferred dividends are earned for 2015, rounding to two decimal places. Can the CEO ensure the creditors and preferred stockholders they will be paid if there is a small decrease?

2015 Interest expense $18,900 Income before income tax 62,300 Tax rate 35% Net income 40,495 10% Preferred stock outstanding, $10 par 1,250,000 Preferred dividends 12,500 Number of times interest charges are earned 4.30 ($62,300 + $18,900)/$18,900 Number of times preferred dividends are earned 3.24 ($40,495/$12,500)

Since Greenwood Paper Supply has a strong number of times interest charges and preferred dividends are earned (both above 1), the company should be able to pay both creditors and preferred stockholders if there is a small decrease in earnings. Strategy: The number of times interest charges are earned should be calculated as the total earnings income taxes divided by interest expense. Since interest expense is tax deductible, it should be added to income before income tax because it generates more earnings (tax savings) for the company. Since dividends are not tax deductible, divide net income by the preferred dividends to calculate number of times preferred dividends are earned. Creditors and preferred stockholders prefer for these ratios to be higher because a higher ratio indicates a higher possibility for payment.



25. Use the information shown to calculate the following ratios for Allen Ales in 2016: ratio of sales to assets, rate earned on total assets, rate earned on stockholders’ equity, and rate earned on common stockholders’ equity. The company paid $2,500 in preferred dividends for the year. Round ratios to two decimal places.

Sales $345,900 Avg. total assets (excluding long-term invest.) $38,625

Interest expense 15,700 Avg. total assets 106,525 Net income 275,300 Avg. total stockholders' equity 38,050 Long-term investments: Avg. common stockholders' equity 27,825 Beg. of year 67,500 End of year 68,300 Ratio of sales to assets 8.96 Total assets: ($345,900/$38,625) Beg. of year 104,750 Rate earned on total assets 2.73 End of year 108,300 ($275,300 + $15,700)/$106,525 Common stockholders' equity: Rate earned on stockholders' equity 7.24 Beg. of year 27,200 ($275,300/$38,050)

End of year 28,450 Rate earned on common stockholders' equity 9.80

Total stockholders' equity: ($275,300 – $2,500)/$27,825 Beg. of year 36,900 End of year 39,200

26. Use the information below to calculate the following ratios for Allen Ales in 2016: earnings per share on common stock, price-earnings ratio, dividends per share, and dividend yield. The company paid $2,500 in preferred dividends for the year. Round ratios to two decimal places.

Net income $275,300 Shares of common stock outstanding 5,750 shares Market price per share of common stock $4.80 Dividends on common stock $10,900

EPS on common stock $47.44($275,300 – $2,500)/5,750 shares P/E ratio 0.10($4.80/$47.44) Dividends per share $1.90($10,900/5,750 shares) Dividend yield $0.40($1.90/$4.80)

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27. Compare the profitability ratios calculated in Exercises 25 and 26 to Allen Ales’ 2015 profitability ratios below. Identify areas that management has been less effective and areas that management has improved.

Ratio of sales to assets 8.61Rate earned on total assets 2.79Rate earned on stockholders' equity 7.83Rate earned on common stockholders' equity 9.56EPS on common stock $52.71P/E ratio 0.08Dividends per share $2.29Dividend yield $0.55

Since the ratio of sales to assets increased, management has increased effectiveness in using assets to generate income in 2016. The rate earned on common stockholders’ equity also increased, demonstrating that common stockholders’ investment in the company has become more profitable. The increase in price-earnings ratio suggests that the company is more profitable for investors. However the decrease in dividends per share suggests that the company is paying less to the investors. The decrease in rate earned on total assets for 2016 suggests that the company has become less efficiency to produce net income with the assets on hand. Since the rate earned per stockholders’ equity also decreased, the company has become less desirable to potential investors, possibly for preferred stockholders, since the rate earned on common stockholders’ equity increased. The decrease in earnings per share on common stock and dividend yield suggests that the company is less profitable compared to the previous year for the investment made by the stockholders. Strategy: Increases in profitability ratios suggest that a company is utilizing its resources, such as investments from stockholders or through the use of assets, more efficiently and effectively. Decreases in profitability show that the company is being less resourceful and producing fewer dollars of earnings per dollar of the input (assets or stockholders’ equity). Investors prefer high profitability ratios, especially ones such as the dividends per share and dividend yield ratio, since they suggest a higher return for the amount invested.



28. What section of the corporate annual report relates to each description? a. Investors are assured that the financial statements are fairly reported

Report on fairness of the financial statements b. Evaluation of the company’s control procedures and its effectiveness

Report on internal controls c. Discussion of any significant changes between the previous year and current

year’s reports Management discussion and analysis

29. Who writes the following in the corporate annual report? a. Discussion of significant risk exposures that might change the company

Management b. Financial statements are fairly represented

Independent auditor (CPA firm) c. Describes who takes responsibility for and oversees internal controls

Management

30. In which section of the corporate annual report would an investor find the following information?

a. Auditor’s opinion Report on fairness of the financial statements

b. Discussion of important accounting policies Management discussion and analysis

c. Discussion of the effectiveness of internal controls Report on internal controls

Strategy: The management discussion and analysis section highlights information that could be relevant to an investor and to the financial statements in the annual report. The report on internal controls is done by management since they are fully responsible for designing and implementing the controls. Independent auditors prepare the report on fairness of the financial statements to reduce the possibility of fraud. If management prepared the report on fairness of the financial statements, they could act unfairly and conceal any evidence.

chapter 15 financial statement analysis study … statement analysis study guide solutions 1 ......

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