Chapter 2 answers

Solutions to Questions and Problems

1. To find owners’ equity, we must construct a balance sheet as follows:

Balance Sheet
CA $ 5,300 CL $ 4,600
NFA 24,900 LTD 10,300
OE ??
TA $30,200 TL & OE $30,200

We know that total liabilities and owners’ equity (TL & OE) must equal total assets of
$30,200. We also know that TL & OE is equal to current liabilities plus long-term debt plus
owners’ equity, so owners’ equity is:

Owner’s equity = $30,200 – 10,300 – 4,600 = $15,300

NWC = CA – CL = $5,300 – 4,600 = $700

2. The income statement for the company is:

Income Statement
Sales $817,000
Costs 343,000
Depreciation 51,000
EBIT $423,000
Interest 38,000
EBT $385,000
Taxes (35%) 134,750
Net income $250,250

3. One equation for net income is:

Net income = Dividends + Addition to retained earnings

Rearranging, we get:

Addition to retained earnings = Net income – Dividends = $250,250 – 95,000 = $155,250

4. EPS = Net income / Shares = $250,250 / 90,000 = $2.78 per share

DPS = Dividends / Shares = $95,000 / 90,000 = $1.06 per share

5. Taxes = .15($50,000) + .25($25,000) + .34($25,000) + .39($267,000 – 100,000) = $87,380

6. The average tax rate is the total tax paid divided by taxable income, so:

Average tax rate = $87,380 / $267,000 = .3273, or 32.73%

The marginal tax rate is the tax rate on the next $1 of earnings, so the marginal tax rate =
39%.

7. To calculate OCF, we first need the income statement:

Income Statement
Sales $43,800
Costs 22,700
Depreciation 2,100
EBIT $19,000
Interest 1,600
Taxable income $17,400
Taxes (35%) 6,090
Net income $11,310

OCF = EBIT + Depreciation – Taxes = $19,000 + 2,100 – 6,090 = $15,010

8. Net capital spending = NFAend – NFAbeg + Depreciation

Net capital spending = $3,500,000 – 2,700,000 + 328,000
Net capital spending = $1,128,000
9. Change in NWC = NWCend – NWCbeg
Change in NWC = (CAend – CLend) – (CAbeg – CLbeg)
Change in NWC = ($5,180 – 2,830) – ($4,630 – 2,190)
Change in NWC = $2,350 – 2,440 = –$90

10. Cash flow to creditors = Interest paid – Net new borrowing

Cash flow to creditors = Interest paid – (LTDend – LTDbeg)
Cash flow to creditors = $235,000 – ($2,280,000 – 1,950,000)
Cash flow to creditors = –$95,000

11. Cash flow to stockholders = Dividends paid – Net new equity

Cash flow to stockholders = Dividends paid – [(Commonend + APISend) – (Commonbeg + APISbeg)]
Cash flow to stockholders = $565,000 – [($825,000 + 4,400,000) – ($670,000 + 4,100,000)]
Cash flow to stockholders = $110,000

Note, APIS is the additional paid-in surplus.

12. Cash flow from assets = Cash flow to creditors + Cash flow to stockholders
= –$95,000 + 110,000 = $15,000

Cash flow from assets = $15,000 = OCF – Change in NWC – Net capital spending
= $15,000 = OCF – (–$45,000) – 1,250,000

Operating cash flow = $15,000 – 45,000 + 1,250,000

Operating cash flow = $1,220,000

13. To find the book value of current assets, we use: NWC = CA – CL. Rearranging to solve for
current assets, we get:

CA = NWC + CL = $220,000 + 850,000 = $1,070,000

The market value of current assets and fixed assets is given, so:

Book value CA = $1,070,000 NWC = $1,050,000

Book value NFA = $3,300,000 Market value NFA = $4,800,000
Book value assets = $4,370,000 Total = $5,850,000
14. To find the OCF, we first calculate net income.

Income Statement
Sales $267,000
Costs 148,000
Other expenses 8,200
Depreciation 17,600
EBIT $ 93,200
Interest 12,400
Taxable income $ 80,800
Taxes 32,620
Net income $ 48,180

Dividends $15,500
Additions to RE $32,680

a. OCF = EBIT + Depreciation – Taxes = $93,200 + 17,600 – 32,620 = $78,180

b. CFC = Interest – Net new LTD = $12,400 – (–4,900) = $17,300

Note that the net new long-term debt is negative because the company repaid part of its
long-
term debt.

c. CFS = Dividends – Net new equity = $15,500 – 6,400 = $9,100

d. We know that CFA = CFC + CFS, so:

CFA = $17,300 + 9,100 = $26,400

CFA is also equal to OCF – Net capital spending – Change in NWC. We already know OCF.
Net capital spending is equal to:

Net capital spending = Increase in NFA + Depreciation = $25,000 + 17,600 = $42,600

Now we can use:

CFA = OCF – Net capital spending – Change in NWC

$26,400 = $78,180 – 42,600 – Change in NWC
Change in NWC = $9,180

This means that the company increased its NWC by $9,180.

16. The balance sheet for the company looks like this:

Balance Sheet
Cash $ 134,000 Accounts payable $ 210,000
Accounts receivable 105,000 Notes payable 160,000
Inventory 293,000 Current liabilities $ 370,000
Current assets $ 532,000 Long-term debt 845,000
Total liabilities $1,215,000
Tangible net fixed assets 1,730,000
Intangible net fixed assets 670,000 Common stock ??
Accumulated ret. earnings 1,453,000
Total assets $2,932,000 Total liab. & owners’ equity $2,932,000

Total liabilities and owners’ equity is:

 TL & OE = CL + LTD + Common stock + Retained earnings

Solving this equation for common stock gives us:

Common stock = $2,932,000 – 1,215,000 – 1,453,000 = $264,000

18.
a. Taxes Growth = .15($50,000) + .25($25,000) + .34($14,500) = $18,680
Taxes Income = .15($50,000) + .25($25,000) + .34($25,000) + .39($235,000)
+ .34($8,950,000 – 335,000) = $3,043,000

b. Each firm has a marginal tax rate of 34% on the next $10,000 of taxable income, despite
their different average tax rates, so both firms will pay an additional $3,400 in taxes.

21. a.
Income Statement
Sales $30,096
Cost of goods sold 21,476
Depreciation 5,341
EBIT $ 3,279
Interest 2,409
Taxable income $ 870
Taxes (35%) 305
Net income $ 566

b. OCF = EBIT + Depreciation – Taxes

= $3,279 + 5,341 – 305 = $8,316
 c. Change in NWC = NWCend – NWCbeg
= (CAend – CLend) – (CAbeg – CLbeg)
= ($7,829 – 4,159) – ($6,336 – 3,564)
= $3,670 – 2,772 = $898

Net capital spending = NFAend – NFAbeg + Depreciation

= $22,176 – 18,018 + 5,341 = $9,499

CFA = OCF – Change in NWC – Net capital spending

= $8,316 – 898 – 9,499 = –$2,082

The cash flow from assets can be positive or negative, since it represents whether the
firm raised funds or distributed funds on a net basis. In this problem, even though net
income and OCF are positive, the firm invested heavily in both fixed assets and net
working capital; it had to raise a net $2,082 in funds from its stockholders and creditors
to make these investments.

d. Cash flow to creditors = Interest – Net new LTD = $2,409 – 0 = $2,409

Cash flow to stockholders = Cash flow from assets – Cash flow to creditors
= –$2,082 – 2,409 = –$4,491

We can also calculate the cash flow to stockholders as:

Cash flow to stockholders = Dividends – Net new equity

Solving for net new equity, we get:

Net new equity = $1,716 – (–4,491) = $6,207

The firm had positive earnings in an accounting sense (NI > 0) and had positive cash flow
from operations. The firm invested $898 in new net working capital and $9,499 in new
fixed assets. The firm had to raise $2,082 from its stakeholders to support this new
investment. It accomplished this by raising $6,207 in the form of new equity. After paying
out $1,716 of this in the form of dividends to shareholders and $2,409 in the form of
interest to creditors, $2,082 was left to meet the firm’s cash flow needs for investment.

22. a. Total assets 2014 = $1,005 + 4,144 = $5,149

Total liabilities 2014 = $402 + 2,190= $2,592
Owners’ equity 2014 = $5,149 – 2,592 = $2,557

Total assets 2015 = $1,089 + 4,990 = $6,079

Total liabilities 2015 = $451 + 2,329 = $2,780
Owners’ equity 2015 = $6,079 – 2,780 = $3,299

b. NWC 2014 = CA14 – CL14 = $1,005 – 402 = $603

NWC 2015 = CA15 – CL15 = $1,089 – 451 = $638
Change in NWC = NWC15 – NWC14 = $638 – 603 = $35
c. We can calculate net capital spending as:

Net capital spending = Net fixed assets 2015 – Net fixed assets 2014 + Depreciation
Net capital spending = $4,990 – 4,144 + 1,136 = $1,982

So, the company had a net capital spending cash flow of $1,982. We also know that net
capital spending is:

Net capital spending = Fixed assets bought – Fixed assets sold

$1,982 = $2,080 – Fixed assets sold
Fixed assets sold = $2,080 – 1,982 = $98

To calculate the cash flow from assets, we must first calculate the operating cash flow.
The income statement is:

Income Statement
Sales $12,751
Costs 5,946
Depreciation expense 1,136
EBIT $ 5,669
Interest expense 323
EBT $ 5,346
Taxes (35%) 1,871
Net income $ 3,475

So, the operating cash flow is:

OCF = EBIT + Depreciation – Taxes = $5,669 + 1,136 – 1,871 = $4,934

And the cash flow from assets is:

Cash flow from assets = OCF – Change in NWC – Net capital spending.
= $4,934 – 35 – 1,982 = $2,917

d. Net new borrowing = LTD15 – LTD14 = $2,329 – 2,190 = $139

Cash flow to creditors = Interest – Net new LTD = $323 – 139 = $184
Net new borrowing = $139 = Debt issued – Debt retired
Debt retired = $420 – 139 = $281
Chapter 3
1. Using the formula for NWC, we get:

NWC = CA – CL
CA = CL + NWC
CA = $4,380 + 1,920
CA = $6,300

So, the current ratio is:

Current ratio = CA / CL
Current ratio = $6,300 / $4,380
Current ratio = 1.44 times

And the quick ratio is:

Quick ratio = (CA – Inventory) / CL

Quick ratio = ($6,300 – 3,750) / $4,380
Quick ratio = .58 times
2. We need to find net income first. So:

Profit margin = Net income / Sales

Net income = Profit margin(Sales)
Net income = .06($17,500,000)
Net income = $1,050,000

ROA = Net income / TA

ROA = $1,050,000 / $13,100,000
ROA = .0802, or 8.02%

To find ROE, we need to find total equity. Since TL & OE equals TA:
TA = TD + TE
TE = TA – TD
TE = $13,100,000 – 5,700,000
TE = $7,400,000

ROE = Net income / TE

ROE = $1,050,000 / $7,400,000
ROE = .1419, or 14.19%

3. Receivables turnover = Sales / Receivables

Receivables turnover = $5,173,820 / $438,720
Receivables turnover = 11.79 times

Days’ sales in receivables = 365 days / Receivables turnover

Days’ sales in receivables = 365 / 11.79
Days’ sales in receivables = 30.95 days

On average, the company’s customers paid off their accounts in 30.95 days.

4. Inventory turnover = COGS / Inventory

Inventory turnover = $4,682,715 / $417,381
Inventory turnover = 11.22 times

Days’ sales in inventory = 365 days / Inventory turnover

Days’ sales in inventory = 365 / 11.22
Days’ sales in inventory = 32.53 days

On average, a unit of inventory sat on the shelf 32.53 days before it was sold.

6. Net income = Addition to RE + Dividends = $395,000 + 195,000 = $590,000

Earnings per share = NI / Shares = $590,000 / 170,000 = $3.47 per

share

Dividends per share = Dividends / Shares = $195,000 / 170,000 = $1.15 per

share

Book value per share = TE / Shares = $5,300,000 / 170,000 = $31.18

per share

Market-to-book ratio = Share price / BVPS = $64 / $31.18 = 2.05 times

P/E ratio = Share price / EPS = $64 / $3.47 = 18.44 times

 Sales per share = Sales / Shares = $5,150,000 / 170,000 = $30.29

P/S ratio = Share price / Sales per share = $64 / $30.29 = 2.11 times

10. The average time to pay suppliers is the days’ sales in payables, so:

Payables turnover = COGS / Accounts payable

Payables turnover = $57,382 / $10,432
Payables turnover = 5.50 times

Days’ sales in payables = 365 days / Payables turnover

Days’ sales in payables = 365 / 5.50
Days’ sales in payables = 66.36 days

The company left its bills to suppliers outstanding for 66.36 days on average. A large value for
this ratio could imply that either (1) the company is having liquidity problems, making it difficult
to pay off its short-term obligations, or (2) that the company has successfully negotiated lenient
credit terms from its suppliers.

17. a. Current ratio = Current assets / Current liabilities

Current ratio 2014 = $90,717 / $62,939 = 1.44 times
Current ratio 2015 = $100,617 / $66,442 = 1.51 times

b. Quick ratio = (Current assets – Inventory) / Current liabilities

Quick ratio 2014 = ($90,717 – 51,163) / $62,939 = .63 times
Quick ratio 2015 = ($100,617 – 56,295) / $66,442 = .67 times
 c. Cash ratio = Cash / Current liabilities
Cash ratio 2014 = $11,135 / $62,939 = .18 times
Cash ratio 2015 = $13,407 / $66,442 = .20 times

d. NWC ratio = NWC / Total assets

NWC ratio 2014 = ($90,717 – 62,939) / $417,173 = .0666, or 6.66%
NWC ratio 2015 = ($100,617 – 66,442) / $458,177 = .0746, or 7.46%

e. Debt-equity ratio = Total debt / Total equity

Debt-equity ratio 2014 = ($62,939 + 44,000) / $310,234 = .34 times
Debt-equity ratio 2015 = ($66,442 + 39,000) / $352,735 = .30 times

Equity multiplier = 1 + D/E

Equity multiplier 2014 = 1 + .34 = 1.34
Equity multiplier 2015 = 1 + .30 = 1.30

f. Total debt ratio = (Total assets – Total equity) / Total assets

Total debt ratio 2014 = ($417,173 – 310,234) / $417,173 = .26 times
Total debt ratio 2015 = ($458,177 – 352,735) / $458,177 = .23 times

Long-term debt ratio = Long-term debt / (Long-term debt + Total equity)

Long-term debt ratio 2014 = $44,000 / ($44,000 + 310,234) = .12 times
Long-term debt ratio 2015 = $39,000 / ($39,000 + 352,735) = .10 times

19. This is a multistep problem involving several ratios. It is often easier to look backward to
determine where to start. We need receivables turnover to find days’ sales in receivables. To
calculate receivables turnover, we need credit sales, and to find credit sales, we need total sales.
Since we are given the profit margin and net income, we can use these to calculate total sales as:

PM = .079 = NI / Sales
PM = $186,000 / Sales
Sales = $2,354,430

Credit sales are 70 percent of total sales, so:

Credit sales = .70($2,354,430)

Credit sales = $1,648,101

Now we can find receivables turnover by:

Receivables turnover = Credit sales / Accounts receivable

Receivables turnover = $1,648,101 / $123,840
Receivables turnover = 13.31 times

Days’ sales in receivables = 365 days / Receivables turnover

Days’ sales in receivables = 365 / 13.31
Days’ sales in receivables = 27.43 days