Essentials of Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate) 9th Edition Solution Manual
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Solutions Manual
Essentials of Corporate Finance
Ross, Westerfield, and Jordan
9th edition
01/03/2016
Prepared by
Brad Jordan
University of Kentucky
Joe Smolira
Belmont University
Essentials of Corporate Finance
Ross, Westerfield, and Jordan
9th edition
01/03/2016
Prepared by
Brad Jordan
University of Kentucky
Joe Smolira
Belmont University
CHAPTER 1
INTRODUCTION TO CORPORATE
FINANCE
Answers to Concepts Review and Critical Thinking Questions
1. Capital budgeting (deciding on whether to expand a manufacturing plant), capital structure (deciding
whether to issue new equity and use the proceeds to retire outstanding debt), and working capital
management (modifying the firm’s credit collection policy with its customers).
2. Disadvantages: unlimited liability, limited life, difficulty in transferring ownership, hard to raise
capital funds. Some advantages: simpler, less regulation, the owners are also the managers, sometimes
personal tax rates are better than corporate tax rates.
3. The primary disadvantage of the corporate form is the double taxation to shareholders of distributed
earnings and dividends. Some advantages include: limited liability, ease of transferability, ability to
raise capital, and unlimited life.
4. The treasurer’s office and the controller’s office are the two primary organizational groups that report
directly to the chief financial officer. The controller’s office handles cost and financial accounting, tax
management, and management information systems. The treasurer’s office is responsible for cash and
credit management, capital budgeting, and financial planning. Therefore, the study of corporate
finance is concentrated within the functions of the treasurer’s office.
5. To maximize the current market value (share price) of the equity of the firm (whether it’s publicly
traded or not).
6. In the corporate form of ownership, the shareholders are the owners of the firm. The shareholders elect
the directors of the corporation, who in turn appoint the firm’s management. This separation of
ownership from control in the corporate form of organization is what causes agency problems to exist.
Management may act in its own or someone else’s best interests, rather than those of the shareholders.
If such events occur, they may contradict the goal of maximizing the share price of the equity of the
firm.
7. A primary market transaction.
8. In auction markets like the NYSE, brokers and agents meet at a physical location (the exchange) to
buy and sell their assets. Dealer markets like NASDAQ represent dealers operating in dispersed locales
who buy and sell assets themselves, usually communicating with other dealers electronically or
literally over the counter.
9. Since such organizations frequently pursue social or political missions, many different goals are
conceivable. One goal that is often cited is revenue minimization; i.e., providing their goods and
INTRODUCTION TO CORPORATE
FINANCE
Answers to Concepts Review and Critical Thinking Questions
1. Capital budgeting (deciding on whether to expand a manufacturing plant), capital structure (deciding
whether to issue new equity and use the proceeds to retire outstanding debt), and working capital
management (modifying the firm’s credit collection policy with its customers).
2. Disadvantages: unlimited liability, limited life, difficulty in transferring ownership, hard to raise
capital funds. Some advantages: simpler, less regulation, the owners are also the managers, sometimes
personal tax rates are better than corporate tax rates.
3. The primary disadvantage of the corporate form is the double taxation to shareholders of distributed
earnings and dividends. Some advantages include: limited liability, ease of transferability, ability to
raise capital, and unlimited life.
4. The treasurer’s office and the controller’s office are the two primary organizational groups that report
directly to the chief financial officer. The controller’s office handles cost and financial accounting, tax
management, and management information systems. The treasurer’s office is responsible for cash and
credit management, capital budgeting, and financial planning. Therefore, the study of corporate
finance is concentrated within the functions of the treasurer’s office.
5. To maximize the current market value (share price) of the equity of the firm (whether it’s publicly
traded or not).
6. In the corporate form of ownership, the shareholders are the owners of the firm. The shareholders elect
the directors of the corporation, who in turn appoint the firm’s management. This separation of
ownership from control in the corporate form of organization is what causes agency problems to exist.
Management may act in its own or someone else’s best interests, rather than those of the shareholders.
If such events occur, they may contradict the goal of maximizing the share price of the equity of the
firm.
7. A primary market transaction.
8. In auction markets like the NYSE, brokers and agents meet at a physical location (the exchange) to
buy and sell their assets. Dealer markets like NASDAQ represent dealers operating in dispersed locales
who buy and sell assets themselves, usually communicating with other dealers electronically or
literally over the counter.
9. Since such organizations frequently pursue social or political missions, many different goals are
conceivable. One goal that is often cited is revenue minimization; i.e., providing their goods and
CHAPTER 1
INTRODUCTION TO CORPORATE
FINANCE
Answers to Concepts Review and Critical Thinking Questions
1. Capital budgeting (deciding on whether to expand a manufacturing plant), capital structure (deciding
whether to issue new equity and use the proceeds to retire outstanding debt), and working capital
management (modifying the firm’s credit collection policy with its customers).
2. Disadvantages: unlimited liability, limited life, difficulty in transferring ownership, hard to raise
capital funds. Some advantages: simpler, less regulation, the owners are also the managers, sometimes
personal tax rates are better than corporate tax rates.
3. The primary disadvantage of the corporate form is the double taxation to shareholders of distributed
earnings and dividends. Some advantages include: limited liability, ease of transferability, ability to
raise capital, and unlimited life.
4. The treasurer’s office and the controller’s office are the two primary organizational groups that report
directly to the chief financial officer. The controller’s office handles cost and financial accounting, tax
management, and management information systems. The treasurer’s office is responsible for cash and
credit management, capital budgeting, and financial planning. Therefore, the study of corporate
finance is concentrated within the functions of the treasurer’s office.
5. To maximize the current market value (share price) of the equity of the firm (whether it’s publicly
traded or not).
6. In the corporate form of ownership, the shareholders are the owners of the firm. The shareholders elect
the directors of the corporation, who in turn appoint the firm’s management. This separation of
ownership from control in the corporate form of organization is what causes agency problems to exist.
Management may act in its own or someone else’s best interests, rather than those of the shareholders.
If such events occur, they may contradict the goal of maximizing the share price of the equity of the
firm.
7. A primary market transaction.
8. In auction markets like the NYSE, brokers and agents meet at a physical location (the exchange) to
buy and sell their assets. Dealer markets like NASDAQ represent dealers operating in dispersed locales
who buy and sell assets themselves, usually communicating with other dealers electronically or
literally over the counter.
9. Since such organizations frequently pursue social or political missions, many different goals are
conceivable. One goal that is often cited is revenue minimization; i.e., providing their goods and
INTRODUCTION TO CORPORATE
FINANCE
Answers to Concepts Review and Critical Thinking Questions
1. Capital budgeting (deciding on whether to expand a manufacturing plant), capital structure (deciding
whether to issue new equity and use the proceeds to retire outstanding debt), and working capital
management (modifying the firm’s credit collection policy with its customers).
2. Disadvantages: unlimited liability, limited life, difficulty in transferring ownership, hard to raise
capital funds. Some advantages: simpler, less regulation, the owners are also the managers, sometimes
personal tax rates are better than corporate tax rates.
3. The primary disadvantage of the corporate form is the double taxation to shareholders of distributed
earnings and dividends. Some advantages include: limited liability, ease of transferability, ability to
raise capital, and unlimited life.
4. The treasurer’s office and the controller’s office are the two primary organizational groups that report
directly to the chief financial officer. The controller’s office handles cost and financial accounting, tax
management, and management information systems. The treasurer’s office is responsible for cash and
credit management, capital budgeting, and financial planning. Therefore, the study of corporate
finance is concentrated within the functions of the treasurer’s office.
5. To maximize the current market value (share price) of the equity of the firm (whether it’s publicly
traded or not).
6. In the corporate form of ownership, the shareholders are the owners of the firm. The shareholders elect
the directors of the corporation, who in turn appoint the firm’s management. This separation of
ownership from control in the corporate form of organization is what causes agency problems to exist.
Management may act in its own or someone else’s best interests, rather than those of the shareholders.
If such events occur, they may contradict the goal of maximizing the share price of the equity of the
firm.
7. A primary market transaction.
8. In auction markets like the NYSE, brokers and agents meet at a physical location (the exchange) to
buy and sell their assets. Dealer markets like NASDAQ represent dealers operating in dispersed locales
who buy and sell assets themselves, usually communicating with other dealers electronically or
literally over the counter.
9. Since such organizations frequently pursue social or political missions, many different goals are
conceivable. One goal that is often cited is revenue minimization; i.e., providing their goods and
CHAPTER 1 – 2
services to society at the lowest possible cost. Another approach might be to observe that even a not-
for-profit business has equity. Thus, an appropriate goal would be to maximize the value of the equity.
10. An argument can be made either way. At one extreme, we could argue that in a market economy, all
of these things are priced. This implies an optimal level of ethical and/or illegal behavior and the
framework of stock valuation explicitly includes these. At the other extreme, we could argue that these
are non-economic phenomena and are best handled through the political process. The following is a
classic (and highly relevant) thought question that illustrates this debate: “A firm has estimated that
the cost of improving the safety of one of its products is $30 million. However, the firm believes that
improving the safety of the product will only save $20 million in product liability claims. What should
the firm do?”
11. The goal will be the same, but the best course of action toward that goal may require adjustments due
to different social, political, and economic climates.
12. The goal of management should be to maximize the share price for the current shareholders. If
management believes that it can improve the profitability of the firm so that the share price will exceed
$35, then they should fight the offer from the outside company. If management believes that this bidder
or other unidentified bidders will actually pay more than $35 per share to acquire the company, then
they should still fight the offer. However, if the current management cannot increase the value of the
firm beyond the bid price, and no other higher bids come in, then management is not acting in the
interests of the shareholders by fighting the offer. Since current managers often lose their jobs when
the corporation is acquired, poorly monitored managers have an incentive to fight corporate takeovers
in situations such as this.
13. We would expect agency problems to be less severe in other countries, primarily due to the relatively
small percentage of individual ownership. Fewer individual owners should reduce the number of
diverse opinions concerning corporate goals. The high percentage of institutional ownership might
lead to a higher degree of agreement between owners and managers on decisions concerning risky
projects. In addition, institutions may be able to implement more effective monitoring mechanisms
than can individual owners, given institutions’ deeper resources and experiences with their own
management. The increase in institutional ownership of stock in the United States and the growing
activism of these large shareholder groups may lead to a reduction in agency problems for U.S.
corporations and a more efficient market for corporate control.
14. How much is too much? Who is worth more, Michael Fries or LeBron James? The simplest answer is
that there is a market for executives just as there is for all types of labor. Executive compensation is
the price that clears the market. The same is true for athletes and performers. Having said that, one
aspect of executive compensation deserves comment. A primary reason executive compensation has
grown so dramatically is that companies have increasingly moved to stock-based compensation. Such
movement is obviously consistent with the attempt to better align stockholder and management
interests. In recent years, stock prices have soared, so management has cleaned up. It is sometimes
argued that much of this reward is simply due to rising stock prices in general, not managerial
performance. Perhaps in the future, executive compensation will be designed to reward only
differential performance, i.e., stock price increases in excess of general market increases.
services to society at the lowest possible cost. Another approach might be to observe that even a not-
for-profit business has equity. Thus, an appropriate goal would be to maximize the value of the equity.
10. An argument can be made either way. At one extreme, we could argue that in a market economy, all
of these things are priced. This implies an optimal level of ethical and/or illegal behavior and the
framework of stock valuation explicitly includes these. At the other extreme, we could argue that these
are non-economic phenomena and are best handled through the political process. The following is a
classic (and highly relevant) thought question that illustrates this debate: “A firm has estimated that
the cost of improving the safety of one of its products is $30 million. However, the firm believes that
improving the safety of the product will only save $20 million in product liability claims. What should
the firm do?”
11. The goal will be the same, but the best course of action toward that goal may require adjustments due
to different social, political, and economic climates.
12. The goal of management should be to maximize the share price for the current shareholders. If
management believes that it can improve the profitability of the firm so that the share price will exceed
$35, then they should fight the offer from the outside company. If management believes that this bidder
or other unidentified bidders will actually pay more than $35 per share to acquire the company, then
they should still fight the offer. However, if the current management cannot increase the value of the
firm beyond the bid price, and no other higher bids come in, then management is not acting in the
interests of the shareholders by fighting the offer. Since current managers often lose their jobs when
the corporation is acquired, poorly monitored managers have an incentive to fight corporate takeovers
in situations such as this.
13. We would expect agency problems to be less severe in other countries, primarily due to the relatively
small percentage of individual ownership. Fewer individual owners should reduce the number of
diverse opinions concerning corporate goals. The high percentage of institutional ownership might
lead to a higher degree of agreement between owners and managers on decisions concerning risky
projects. In addition, institutions may be able to implement more effective monitoring mechanisms
than can individual owners, given institutions’ deeper resources and experiences with their own
management. The increase in institutional ownership of stock in the United States and the growing
activism of these large shareholder groups may lead to a reduction in agency problems for U.S.
corporations and a more efficient market for corporate control.
14. How much is too much? Who is worth more, Michael Fries or LeBron James? The simplest answer is
that there is a market for executives just as there is for all types of labor. Executive compensation is
the price that clears the market. The same is true for athletes and performers. Having said that, one
aspect of executive compensation deserves comment. A primary reason executive compensation has
grown so dramatically is that companies have increasingly moved to stock-based compensation. Such
movement is obviously consistent with the attempt to better align stockholder and management
interests. In recent years, stock prices have soared, so management has cleaned up. It is sometimes
argued that much of this reward is simply due to rising stock prices in general, not managerial
performance. Perhaps in the future, executive compensation will be designed to reward only
differential performance, i.e., stock price increases in excess of general market increases.
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3 – SOLUTIONS MANUAL
15. The biggest reason that a company would “go dark” is because of the increased audit costs associated
with Sarbanes-Oxley compliance. A company should always do a cost-benefit analysis, and it may be
the case that the costs of complying with Sarbox outweigh the benefits. Of course, the company could
always be trying to hide financial issues of the company! This is also one of the costs of going dark:
Investors surely believe that some companies are going dark to avoid the increased scrutiny from
Sarbox. This taints other companies that go dark just to avoid compliance costs. This is similar to the
lemon problem with used automobiles: Buyers tend to underpay because they know a certain
percentage of used cars are lemons. So, investors will tend to pay less for the company stock than they
otherwise would. It is important to note that even if the company delists, its stock is still likely traded,
but on the over-the-counter market pink sheets rather than on an organized exchange. This adds
another cost since the stock is likely to be less liquid now. All else the same, investors pay less for an
asset with less liquidity. Overall, the cost to the company is likely a reduced market value. Whether
delisting is good or bad for investors depends on the individual circumstances of the company. It is
also important to remember that there are already many small companies that file only limited financial
information.
15. The biggest reason that a company would “go dark” is because of the increased audit costs associated
with Sarbanes-Oxley compliance. A company should always do a cost-benefit analysis, and it may be
the case that the costs of complying with Sarbox outweigh the benefits. Of course, the company could
always be trying to hide financial issues of the company! This is also one of the costs of going dark:
Investors surely believe that some companies are going dark to avoid the increased scrutiny from
Sarbox. This taints other companies that go dark just to avoid compliance costs. This is similar to the
lemon problem with used automobiles: Buyers tend to underpay because they know a certain
percentage of used cars are lemons. So, investors will tend to pay less for the company stock than they
otherwise would. It is important to note that even if the company delists, its stock is still likely traded,
but on the over-the-counter market pink sheets rather than on an organized exchange. This adds
another cost since the stock is likely to be less liquid now. All else the same, investors pay less for an
asset with less liquidity. Overall, the cost to the company is likely a reduced market value. Whether
delisting is good or bad for investors depends on the individual circumstances of the company. It is
also important to remember that there are already many small companies that file only limited financial
information.
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CHAPTER 2
WORKING WITH FINANCIAL
STATEMENTS
Answers to Concepts Review and Critical Thinking Questions
1. Liquidity measures how quickly and easily an asset can be converted to cash without significant loss
in value. It’s desirable for firms to have high liquidity so that they can more safely meet short-term
creditor demands. However, liquidity also has an opportunity cost. Firms generally reap higher returns
by investing in illiquid, productive assets. It’s up to the firm’s financial management staff to find a
reasonable compromise between these opposing needs.
2. The recognition and matching principles in financial accounting call for revenues, and the costs
associated with producing those revenues, to be “booked” when the revenue process is essentially
complete, not necessarily when the cash is collected or bills are paid. Note that this way is not
necessarily correct; it’s the way accountants have chosen to do it.
3. Historical costs can be objectively and precisely measured, whereas market values can be difficult to
estimate, and different analysts would come up with different numbers. Thus, there is a tradeoff
between relevance (market values) and objectivity (book values).
4. Depreciation is a non-cash deduction that reflects adjustments made in asset book values in accordance
with the matching principle in financial accounting. Interest expense is a cash outlay, but it’s a
financing cost, not an operating cost.
5. Market values can never be negative. Imagine a share of stock selling for –$20. This would mean that
if you placed an order for 100 shares, you would get the stock along with a check for $2,000. How
many shares do you want to buy? More generally, because of corporate and individual bankruptcy
laws, net worth for a person or a corporation cannot be negative, implying that liabilities cannot exceed
assets in market value.
6. For a successful company that is rapidly expanding, capital outlays would typically be large, possibly
leading to negative cash flow from assets. In general, what matters is whether the money is spent
wisely, not whether cash flow from assets is positive or negative.
7. It’s probably not a good sign for an established company, but it would be fairly ordinary for a start-
up, so it depends.
8. For example, if a company were to become more efficient in inventory management, the amount of
inventory needed would decline. The same might be true if it becomes better at collecting its
receivables. In general, anything that leads to a decline in ending NWC relative to beginning NWC
would have this effect. Negative net capital spending would mean more long-lived assets were
liquidated than purchased.
WORKING WITH FINANCIAL
STATEMENTS
Answers to Concepts Review and Critical Thinking Questions
1. Liquidity measures how quickly and easily an asset can be converted to cash without significant loss
in value. It’s desirable for firms to have high liquidity so that they can more safely meet short-term
creditor demands. However, liquidity also has an opportunity cost. Firms generally reap higher returns
by investing in illiquid, productive assets. It’s up to the firm’s financial management staff to find a
reasonable compromise between these opposing needs.
2. The recognition and matching principles in financial accounting call for revenues, and the costs
associated with producing those revenues, to be “booked” when the revenue process is essentially
complete, not necessarily when the cash is collected or bills are paid. Note that this way is not
necessarily correct; it’s the way accountants have chosen to do it.
3. Historical costs can be objectively and precisely measured, whereas market values can be difficult to
estimate, and different analysts would come up with different numbers. Thus, there is a tradeoff
between relevance (market values) and objectivity (book values).
4. Depreciation is a non-cash deduction that reflects adjustments made in asset book values in accordance
with the matching principle in financial accounting. Interest expense is a cash outlay, but it’s a
financing cost, not an operating cost.
5. Market values can never be negative. Imagine a share of stock selling for –$20. This would mean that
if you placed an order for 100 shares, you would get the stock along with a check for $2,000. How
many shares do you want to buy? More generally, because of corporate and individual bankruptcy
laws, net worth for a person or a corporation cannot be negative, implying that liabilities cannot exceed
assets in market value.
6. For a successful company that is rapidly expanding, capital outlays would typically be large, possibly
leading to negative cash flow from assets. In general, what matters is whether the money is spent
wisely, not whether cash flow from assets is positive or negative.
7. It’s probably not a good sign for an established company, but it would be fairly ordinary for a start-
up, so it depends.
8. For example, if a company were to become more efficient in inventory management, the amount of
inventory needed would decline. The same might be true if it becomes better at collecting its
receivables. In general, anything that leads to a decline in ending NWC relative to beginning NWC
would have this effect. Negative net capital spending would mean more long-lived assets were
liquidated than purchased.
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5 – SOLUTIONS MANUAL
9. If a company raises more money from selling stock than it pays in dividends in a particular period, its
cash flow to stockholders will be negative. If a company borrows more than it pays in interest, its cash
flow to creditors will be negative.
10. The adjustments discussed were purely accounting changes; they had no cash flow or market value
consequences unless the new accounting information caused stockholders to revalue the company.
Solutions to Questions and Problems
NOTE: All end-of-chapter problems were solved using a spreadsheet. Many problems require multiple
steps. Due to space and readability constraints, when these intermediate steps are included in this solutions
manual, rounding may appear to have occurred. However, the final answer for each problem is found
without rounding during any step in the problem.
Basic
1. The balance sheet for the company will look like this:
Balance sheet
Current assets $2,030 Current liabilities $1,640
Net fixed assets 9,780 Long-term debt 4,490
Owners’ equity 5,680
Total assets $11,810 Total liabilities and owners’ equity $11,810
The owners’ equity is a plug variable. We know that total assets must equal total liabilities and owners’
equity. Total liabilities and owners’ equity is the sum of all debt and equity, so if we subtract debt
from total liabilities and owners’ equity, the remainder must be the equity balance, so:
Owners’ equity = Total liabilities and owners’ equity – Current liabilities – Long-term debt
Owners’ equity = $11,810 – 1,640 – 4,490
Owners’ equity = $5,680
Net working capital is current assets minus current liabilities, so:
NWC = Current assets – Current liabilities
NWC = $2,030 – 1,640
NWC = $390
9. If a company raises more money from selling stock than it pays in dividends in a particular period, its
cash flow to stockholders will be negative. If a company borrows more than it pays in interest, its cash
flow to creditors will be negative.
10. The adjustments discussed were purely accounting changes; they had no cash flow or market value
consequences unless the new accounting information caused stockholders to revalue the company.
Solutions to Questions and Problems
NOTE: All end-of-chapter problems were solved using a spreadsheet. Many problems require multiple
steps. Due to space and readability constraints, when these intermediate steps are included in this solutions
manual, rounding may appear to have occurred. However, the final answer for each problem is found
without rounding during any step in the problem.
Basic
1. The balance sheet for the company will look like this:
Balance sheet
Current assets $2,030 Current liabilities $1,640
Net fixed assets 9,780 Long-term debt 4,490
Owners’ equity 5,680
Total assets $11,810 Total liabilities and owners’ equity $11,810
The owners’ equity is a plug variable. We know that total assets must equal total liabilities and owners’
equity. Total liabilities and owners’ equity is the sum of all debt and equity, so if we subtract debt
from total liabilities and owners’ equity, the remainder must be the equity balance, so:
Owners’ equity = Total liabilities and owners’ equity – Current liabilities – Long-term debt
Owners’ equity = $11,810 – 1,640 – 4,490
Owners’ equity = $5,680
Net working capital is current assets minus current liabilities, so:
NWC = Current assets – Current liabilities
NWC = $2,030 – 1,640
NWC = $390
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CHAPTER 2 – 6
2. The income statement starts with revenues and subtracts costs to arrive at EBIT. We then subtract out
interest to get taxable income, and then subtract taxes to arrive at net income. Doing so, we get:
Income Statement
Sales $634,000
Costs 328,000
Depreciation 73,000
EBIT $233,000
Interest 38,000
Taxable income $195,000
Taxes 68,250
Net income $126,750
3. The dividends paid plus the addition to retained earnings must equal net income, so:
Net income = Dividends + Addition to retained earnings
Addition to retained earnings = $126,750 – 43,000
Addition to retained earnings = $83,750
4. Earnings per share is the net income divided by the shares outstanding, so:
EPS = Net income / Shares outstanding
EPS = $126,750 / 35,000
EPS = $3.62 per share
And dividends per share are the total dividends paid divided by the shares outstanding, so:
DPS = Dividends / Shares outstanding
DPS = $43,000 / 35,000
DPS = $1.23 per share
5. Using Table 2.3, we can see the marginal tax schedule. The first $50,000 of income is taxed at 15
percent, the next $25,000 is taxed at 25 percent, the next $25,000 is taxed at 34 percent, and the next
$143,000 is taxed at 39 percent. So, the total taxes for the company will be:
Taxes = .15($50,000) + .25($25,000) + .34($25,000) + .39($243,000 – 100,000)
Taxes = $78,020
6. The average tax rate is the total taxes paid divided by taxable income, so:
Average tax rate = Total tax / Taxable income
Average tax rate = $78,020 / $243,000
Average tax rate = .3211, or 32.11%
The marginal tax rate is the tax rate on the next dollar of income. The company has net income of
$243,000 and the 39 percent tax bracket is applicable to a net income up to $335,000, so the marginal
tax rate is 39 percent.
2. The income statement starts with revenues and subtracts costs to arrive at EBIT. We then subtract out
interest to get taxable income, and then subtract taxes to arrive at net income. Doing so, we get:
Income Statement
Sales $634,000
Costs 328,000
Depreciation 73,000
EBIT $233,000
Interest 38,000
Taxable income $195,000
Taxes 68,250
Net income $126,750
3. The dividends paid plus the addition to retained earnings must equal net income, so:
Net income = Dividends + Addition to retained earnings
Addition to retained earnings = $126,750 – 43,000
Addition to retained earnings = $83,750
4. Earnings per share is the net income divided by the shares outstanding, so:
EPS = Net income / Shares outstanding
EPS = $126,750 / 35,000
EPS = $3.62 per share
And dividends per share are the total dividends paid divided by the shares outstanding, so:
DPS = Dividends / Shares outstanding
DPS = $43,000 / 35,000
DPS = $1.23 per share
5. Using Table 2.3, we can see the marginal tax schedule. The first $50,000 of income is taxed at 15
percent, the next $25,000 is taxed at 25 percent, the next $25,000 is taxed at 34 percent, and the next
$143,000 is taxed at 39 percent. So, the total taxes for the company will be:
Taxes = .15($50,000) + .25($25,000) + .34($25,000) + .39($243,000 – 100,000)
Taxes = $78,020
6. The average tax rate is the total taxes paid divided by taxable income, so:
Average tax rate = Total tax / Taxable income
Average tax rate = $78,020 / $243,000
Average tax rate = .3211, or 32.11%
The marginal tax rate is the tax rate on the next dollar of income. The company has net income of
$243,000 and the 39 percent tax bracket is applicable to a net income up to $335,000, so the marginal
tax rate is 39 percent.
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7 – SOLUTIONS MANUAL
7. To calculate the OCF, we first need to construct an income statement. The income statement starts
with revenues and subtracts costs to arrive at EBIT. We then subtract out interest to get taxable income,
and then subtract taxes to arrive at net income. Doing so, we get:
Income Statement
Sales $38,530
Costs 12,750
Depreciation 2,550
EBIT $23,230
Interest 1,850
Taxable income $21,380
Taxes (35%) 7,483
Net income $13.897
Now we can calculate the OCF, which is:
OCF = EBIT + Depreciation – Taxes
OCF = $23,230 + 2,550 – 7,483
OCF = $18,297
8. Net capital spending is the increase in fixed assets, plus depreciation. Using this relationship, we find:
Net capital spending = NFAend – NFAbeg + Depreciation
Net capital spending = $2,134,000 – 1,975,000 + 325,000
Net capital spending = $484,000
9. The change in net working capital is the end of period net working capital minus the beginning of
period net working capital, so:
Change in NWC = NWCend – NWCbeg
Change in NWC = (CAend – CLend) – (CAbeg – CLbeg)
Change in NWC = ($1,685 – 1,305) – (1,530 – 1,270)
Change in NWC = $120
10. The cash flow to creditors is the interest paid, minus any net new borrowing, so:
Cash flow to creditors = Interest paid – Net new borrowing
Cash flow to creditors = Interest paid – (LTDend – LTDbeg)
Cash flow to creditors = $102,800 – ($1,551,000 – 1,410,000)
Cash flow to creditors = –$38,200
11. The cash flow to stockholders is the dividends paid minus any new equity raised. So, the cash flow to
stockholders is: (Note that APIS is the additional paid-in surplus.)
Cash flow to stockholders = Dividends paid – Net new equity
Cash flow to stockholders = Dividends paid – [(Commonend + APISend) – (Commonbeg + APISbeg)]
Cash flow to stockholders = $148,500 – [($148,000 + 2,618,000) – ($130,000 + 2,332,000)]
Cash flow to stockholders = –$155,500
12. We know that cash flow from assets is equal to cash flow to creditors plus cash flow to stockholders.
So, cash flow from assets is:
7. To calculate the OCF, we first need to construct an income statement. The income statement starts
with revenues and subtracts costs to arrive at EBIT. We then subtract out interest to get taxable income,
and then subtract taxes to arrive at net income. Doing so, we get:
Income Statement
Sales $38,530
Costs 12,750
Depreciation 2,550
EBIT $23,230
Interest 1,850
Taxable income $21,380
Taxes (35%) 7,483
Net income $13.897
Now we can calculate the OCF, which is:
OCF = EBIT + Depreciation – Taxes
OCF = $23,230 + 2,550 – 7,483
OCF = $18,297
8. Net capital spending is the increase in fixed assets, plus depreciation. Using this relationship, we find:
Net capital spending = NFAend – NFAbeg + Depreciation
Net capital spending = $2,134,000 – 1,975,000 + 325,000
Net capital spending = $484,000
9. The change in net working capital is the end of period net working capital minus the beginning of
period net working capital, so:
Change in NWC = NWCend – NWCbeg
Change in NWC = (CAend – CLend) – (CAbeg – CLbeg)
Change in NWC = ($1,685 – 1,305) – (1,530 – 1,270)
Change in NWC = $120
10. The cash flow to creditors is the interest paid, minus any net new borrowing, so:
Cash flow to creditors = Interest paid – Net new borrowing
Cash flow to creditors = Interest paid – (LTDend – LTDbeg)
Cash flow to creditors = $102,800 – ($1,551,000 – 1,410,000)
Cash flow to creditors = –$38,200
11. The cash flow to stockholders is the dividends paid minus any new equity raised. So, the cash flow to
stockholders is: (Note that APIS is the additional paid-in surplus.)
Cash flow to stockholders = Dividends paid – Net new equity
Cash flow to stockholders = Dividends paid – [(Commonend + APISend) – (Commonbeg + APISbeg)]
Cash flow to stockholders = $148,500 – [($148,000 + 2,618,000) – ($130,000 + 2,332,000)]
Cash flow to stockholders = –$155,500
12. We know that cash flow from assets is equal to cash flow to creditors plus cash flow to stockholders.
So, cash flow from assets is:
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CHAPTER 2 – 8
Cash flow from assets = Cash flow to creditors + Cash flow to stockholders
Cash flow from assets = –$38,200 – 155,500
Cash flow from assets = –$193,700
We also know that cash flow from assets is equal to the operating cash flow minus the change in net
working capital and the net capital spending. We can use this relationship to find the operating cash
flow. Doing so, we find:
Cash flow from assets = OCF – Change in NWC – Net capital spending
–$193,700 = OCF – (–$115,000) – (705,000)
OCF = –$193,700 – 115,000 + 705,000
OCF = $396,300
Intermediate
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. a. To calculate the OCF, we first need to construct an income statement. The income statement starts
with revenues and subtracts costs to arrive at EBIT. We then subtract out interest to get taxable
income, and then subtract taxes to arrive at net income. Doing so, we get:
Income Statement
Sales $173,000
Costs 91,400
Other Expenses 5,100
Depreciation 12,100
EBIT $64,400
Interest 8,900
Taxable income $55,500
Taxes 21,090
Net income $34,410
Dividends $9,700
Addition to retained earnings 24,710
Cash flow from assets = Cash flow to creditors + Cash flow to stockholders
Cash flow from assets = –$38,200 – 155,500
Cash flow from assets = –$193,700
We also know that cash flow from assets is equal to the operating cash flow minus the change in net
working capital and the net capital spending. We can use this relationship to find the operating cash
flow. Doing so, we find:
Cash flow from assets = OCF – Change in NWC – Net capital spending
–$193,700 = OCF – (–$115,000) – (705,000)
OCF = –$193,700 – 115,000 + 705,000
OCF = $396,300
Intermediate
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. a. To calculate the OCF, we first need to construct an income statement. The income statement starts
with revenues and subtracts costs to arrive at EBIT. We then subtract out interest to get taxable
income, and then subtract taxes to arrive at net income. Doing so, we get:
Income Statement
Sales $173,000
Costs 91,400
Other Expenses 5,100
Depreciation 12,100
EBIT $64,400
Interest 8,900
Taxable income $55,500
Taxes 21,090
Net income $34,410
Dividends $9,700
Addition to retained earnings 24,710
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9 – SOLUTIONS MANUAL
Dividends paid plus addition to retained earnings must equal net income, so:
Net income = Dividends + Addition to retained earnings
Addition to retained earnings = $34,410 – 9,700
Addition to retained earnings = $24,710
So, the operating cash flow is:
OCF = EBIT + Depreciation – Taxes
OCF = $64,400 + 12,100 – 21,090
OCF = $55,410
b. The cash flow to creditors is the interest paid, minus any new borrowing. Since the company
redeemed long-term debt, the net new borrowing is negative. So, the cash flow to creditors is:
Cash flow to creditors = Interest paid – Net new borrowing
Cash flow to creditors = $8,900 – (–$4,000)
Cash flow to creditors = $12,900
c. The cash flow to stockholders is the dividends paid minus any new equity. So, the cash flow to
stockholders is:
Cash flow to stockholders = Dividends paid – Net new equity
Cash flow to stockholders = $9,700 – 2,900
Cash flow to stockholders = $6,800
d. In this case, to find the addition to NWC, we need to find the cash flow from assets. We can then
use the cash flow from assets equation to find the change in NWC. We know that cash flow from
assets is equal to cash flow to creditors plus cash flow to stockholders. So, cash flow from assets
is:
Cash flow from assets = Cash flow to creditors + Cash flow to stockholders
Cash flow from assets = $12,900 + 6,800
Cash flow from assets = $19,700
Net capital spending is equal to depreciation plus the increase in fixed assets, so:
Net capital spending = Depreciation + Increase in fixed assets
Net capital spending = $12,100 + 23,140
Net capital spending = $35,240
Now we can use the cash flow from assets equation to find the change in NWC. Doing so, we find:
Cash flow from assets = OCF – Change in NWC – Net capital spending
$19,700 = $55,410 – Change in NWC – $35,240
Change in NWC = $470
Dividends paid plus addition to retained earnings must equal net income, so:
Net income = Dividends + Addition to retained earnings
Addition to retained earnings = $34,410 – 9,700
Addition to retained earnings = $24,710
So, the operating cash flow is:
OCF = EBIT + Depreciation – Taxes
OCF = $64,400 + 12,100 – 21,090
OCF = $55,410
b. The cash flow to creditors is the interest paid, minus any new borrowing. Since the company
redeemed long-term debt, the net new borrowing is negative. So, the cash flow to creditors is:
Cash flow to creditors = Interest paid – Net new borrowing
Cash flow to creditors = $8,900 – (–$4,000)
Cash flow to creditors = $12,900
c. The cash flow to stockholders is the dividends paid minus any new equity. So, the cash flow to
stockholders is:
Cash flow to stockholders = Dividends paid – Net new equity
Cash flow to stockholders = $9,700 – 2,900
Cash flow to stockholders = $6,800
d. In this case, to find the addition to NWC, we need to find the cash flow from assets. We can then
use the cash flow from assets equation to find the change in NWC. We know that cash flow from
assets is equal to cash flow to creditors plus cash flow to stockholders. So, cash flow from assets
is:
Cash flow from assets = Cash flow to creditors + Cash flow to stockholders
Cash flow from assets = $12,900 + 6,800
Cash flow from assets = $19,700
Net capital spending is equal to depreciation plus the increase in fixed assets, so:
Net capital spending = Depreciation + Increase in fixed assets
Net capital spending = $12,100 + 23,140
Net capital spending = $35,240
Now we can use the cash flow from assets equation to find the change in NWC. Doing so, we find:
Cash flow from assets = OCF – Change in NWC – Net capital spending
$19,700 = $55,410 – Change in NWC – $35,240
Change in NWC = $470
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CHAPTER 2 – 10
15. Here we need to work the income statement backward. Starting with net income, we know that net
income is:
Net income = Dividends + Addition to retained earnings
Net income = $2,170 + 3,500
Net income = $5,670
Net income is also the taxable income, minus the taxable income times the tax rate, or:
Net income = Taxable income – (Taxable income)(Tax rate)
Net income = Taxable income(1 – Tax rate)
We can rearrange this equation and solve for the taxable income as:
Taxable income = Net income / (1 – Tax rate)
Taxable income = $5,670 / (1 – .40)
Taxable income = $9,450
EBIT minus interest equals taxable income, so rearranging this relationship, we find:
EBIT = Taxable income + Interest
EBIT = $9,450 + 1,980
EBIT = $11,430
Now that we have the EBIT, we know that sales minus costs minus depreciation equals EBIT. Solving
this equation for EBIT, we find:
EBIT = Sales – Costs – Depreciation
$11,430 = $67,000 – 49,200 – Depreciation
Depreciation = $6,370
16. We can fill in the balance sheet with the numbers we are given. The balance sheet will be:
Balance Sheet
Cash $197,000 Accounts payable $288,000
Accounts receivable 265,000 Notes payable 194,000
Inventory 563,000 Current liabilities $482,000
Current assets $1,025,000 Long-term debt 1,490,000
Total liabilities $2,072,000
Tangible net fixed assets $5,150,000
Intangible net fixed assets 863,000 Common stock ??
Accumulated retained earnings 4,586,000
Total assets $7,038,000 Total liabilities & owners’ equity $7,038,000
Total liabilities and owners’ equity is:
TL & OE = CL + LTD + Common stock + Retained earnings
15. Here we need to work the income statement backward. Starting with net income, we know that net
income is:
Net income = Dividends + Addition to retained earnings
Net income = $2,170 + 3,500
Net income = $5,670
Net income is also the taxable income, minus the taxable income times the tax rate, or:
Net income = Taxable income – (Taxable income)(Tax rate)
Net income = Taxable income(1 – Tax rate)
We can rearrange this equation and solve for the taxable income as:
Taxable income = Net income / (1 – Tax rate)
Taxable income = $5,670 / (1 – .40)
Taxable income = $9,450
EBIT minus interest equals taxable income, so rearranging this relationship, we find:
EBIT = Taxable income + Interest
EBIT = $9,450 + 1,980
EBIT = $11,430
Now that we have the EBIT, we know that sales minus costs minus depreciation equals EBIT. Solving
this equation for EBIT, we find:
EBIT = Sales – Costs – Depreciation
$11,430 = $67,000 – 49,200 – Depreciation
Depreciation = $6,370
16. We can fill in the balance sheet with the numbers we are given. The balance sheet will be:
Balance Sheet
Cash $197,000 Accounts payable $288,000
Accounts receivable 265,000 Notes payable 194,000
Inventory 563,000 Current liabilities $482,000
Current assets $1,025,000 Long-term debt 1,490,000
Total liabilities $2,072,000
Tangible net fixed assets $5,150,000
Intangible net fixed assets 863,000 Common stock ??
Accumulated retained earnings 4,586,000
Total assets $7,038,000 Total liabilities & owners’ equity $7,038,000
Total liabilities and owners’ equity is:
TL & OE = CL + LTD + Common stock + Retained earnings
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11 – SOLUTIONS MANUAL
Solving for this equation for common stock gives us:
Common stock = $7,038,000 – 4,586,000 – 2,072,000
Common stock = $380,000
17. Owners’ equity is the maximum of total assets minus total liabilities, or zero. Although the book value
of owners’ equity can be negative, the market value of owners’ equity cannot be negative, so:
Owners’ equity = Max [(TA – TL), 0]
a. If total assets are $9,300, the owners’ equity is:
Owners’ equity = Max[($9,300 – 8,400), 0]
Owners’ equity = $900
b. If total assets are $6,900, the owners’ equity is:
Owners’ equity = Max[($6,900 – 8,400), 0]
Owners’ equity = $0
18. a. Using Table 2.3, we can see the marginal tax schedule. For Corporation Growth, the first $50,000
of income is taxed at 15 percent, the next $25,000 is taxed at 25 percent, and the next $1,500 is
taxed at 34 percent. So, the total taxes for the company will be:
TaxesGrowth = .15($50,000) + .25($25,000) + .34($1,500)
TaxesGrowth = $14,260
For Corporation Income, the first $50,000 of income is taxed at 15 percent, the next $25,000 is
taxed at 25 percent, the next $25,000 is taxed at 34 percent, the next $235,000 is taxed at 39 percent,
and the next $7,315,000 is taxed at 34 percent. So, the total taxes for the company will be:
TaxesIncome = .15($50,000) + .25($25,000) + .34($25,000) + .39($235,000)
+ .34($7,315,000)
TaxesIncome = $2,601,000
b. The marginal tax rate is the tax rate on the next $1 of earnings. 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.
Solving for this equation for common stock gives us:
Common stock = $7,038,000 – 4,586,000 – 2,072,000
Common stock = $380,000
17. Owners’ equity is the maximum of total assets minus total liabilities, or zero. Although the book value
of owners’ equity can be negative, the market value of owners’ equity cannot be negative, so:
Owners’ equity = Max [(TA – TL), 0]
a. If total assets are $9,300, the owners’ equity is:
Owners’ equity = Max[($9,300 – 8,400), 0]
Owners’ equity = $900
b. If total assets are $6,900, the owners’ equity is:
Owners’ equity = Max[($6,900 – 8,400), 0]
Owners’ equity = $0
18. a. Using Table 2.3, we can see the marginal tax schedule. For Corporation Growth, the first $50,000
of income is taxed at 15 percent, the next $25,000 is taxed at 25 percent, and the next $1,500 is
taxed at 34 percent. So, the total taxes for the company will be:
TaxesGrowth = .15($50,000) + .25($25,000) + .34($1,500)
TaxesGrowth = $14,260
For Corporation Income, the first $50,000 of income is taxed at 15 percent, the next $25,000 is
taxed at 25 percent, the next $25,000 is taxed at 34 percent, the next $235,000 is taxed at 39 percent,
and the next $7,315,000 is taxed at 34 percent. So, the total taxes for the company will be:
TaxesIncome = .15($50,000) + .25($25,000) + .34($25,000) + .39($235,000)
+ .34($7,315,000)
TaxesIncome = $2,601,000
b. The marginal tax rate is the tax rate on the next $1 of earnings. 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.
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CHAPTER 2 – 12
19. a. The income statement starts with revenues and subtracts costs to arrive at EBIT. We then subtract
interest to get taxable income, and then subtract taxes to arrive at net income. Doing so, we get:
Income Statement
Sales $2,350,000
Cost of goods sold 1,925,000
Admin expenses 530,000
Depreciation 420,000
EBIT $ 105,000
Interest 245,000
Taxable income –$140,000
Taxes (35%) 0
Net income –$140,000
The taxes are zero since we are ignoring any carryback or carryforward provisions.
b. The operating cash flow for the year was:
OCF = EBIT + Depreciation – Taxes
OCF = $105,000 + 420,000 – 0
OCF = $525,000
c. Net income was negative because of the tax deductibility of depreciation and interest expense.
However, the actual cash flow from operations was positive because depreciation is a non-cash
expense and interest is a financing, not an operating, expense.
20. A firm can still pay out dividends if net income is negative; it just has to be sure there is sufficient
cash flow to make the dividend payments. The assumptions made in the question are:
Change in NWC = Net capital spending = Net new equity = 0
To find the new long-term debt, we first need to find the cash flow from assets. The cash flow from
assets is:
Cash flow from assets = OCF – Change in NWC – Net capital spending
Cash flow from assets = $525,000 – 0 – 0
Cash flow from assets = $525,000
We can also find the cash flow to stockholders, which is:
Cash flow to stockholders = Dividends – Net new equity
Cash flow to stockholders = $395,000 – 0
Cash flow to stockholders = $395,000
Now we can use the cash flow from assets equation to find the cash flow to creditors. Doing so, we
get:
Cash flow from assets = Cash flow to creditors + Cash flow to stockholders
$525,000 = Cash flow to creditors + $395,000
Cash flow to creditors = $130,000
19. a. The income statement starts with revenues and subtracts costs to arrive at EBIT. We then subtract
interest to get taxable income, and then subtract taxes to arrive at net income. Doing so, we get:
Income Statement
Sales $2,350,000
Cost of goods sold 1,925,000
Admin expenses 530,000
Depreciation 420,000
EBIT $ 105,000
Interest 245,000
Taxable income –$140,000
Taxes (35%) 0
Net income –$140,000
The taxes are zero since we are ignoring any carryback or carryforward provisions.
b. The operating cash flow for the year was:
OCF = EBIT + Depreciation – Taxes
OCF = $105,000 + 420,000 – 0
OCF = $525,000
c. Net income was negative because of the tax deductibility of depreciation and interest expense.
However, the actual cash flow from operations was positive because depreciation is a non-cash
expense and interest is a financing, not an operating, expense.
20. A firm can still pay out dividends if net income is negative; it just has to be sure there is sufficient
cash flow to make the dividend payments. The assumptions made in the question are:
Change in NWC = Net capital spending = Net new equity = 0
To find the new long-term debt, we first need to find the cash flow from assets. The cash flow from
assets is:
Cash flow from assets = OCF – Change in NWC – Net capital spending
Cash flow from assets = $525,000 – 0 – 0
Cash flow from assets = $525,000
We can also find the cash flow to stockholders, which is:
Cash flow to stockholders = Dividends – Net new equity
Cash flow to stockholders = $395,000 – 0
Cash flow to stockholders = $395,000
Now we can use the cash flow from assets equation to find the cash flow to creditors. Doing so, we
get:
Cash flow from assets = Cash flow to creditors + Cash flow to stockholders
$525,000 = Cash flow to creditors + $395,000
Cash flow to creditors = $130,000
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13 – SOLUTIONS MANUAL
Now we can use the cash flow to creditors equation to find:
Cash flow to creditors = Interest – Net new long-term debt
$130,000 = $245,000 – Net new long-term debt
Net new long-term debt = $115,000
21. a. To calculate the OCF, we first need to construct an income statement. The income statement starts
with revenues and subtracts costs to arrive at EBIT. We then subtract out interest to get taxable
income, and then subtract taxes to arrive at net income. Doing so, we get:
Income Statement
Sales $28,476
Cost of goods sold 20,136
Depreciation 3,408
EBIT $ 4,932
Interest 497
Taxable income $ 4,435
Taxes (40%) 1,774
Net income $ 2,661
b. The operating cash flow for the year was:
OCF = EBIT + Depreciation – Taxes
OCF = $4,932 + 3,408 – 1,774
OCF = $6,566
c. To calculate the cash flow from assets, we also need the change in net working capital and net
capital spending. The change in net working capital was:
Change in NWC = NWCend – NWCbeg
Change in NWC = (CAend – CLend) – (CAbeg – CLbeg)
Change in NWC = ($4,234 – 2,981) – ($3,528 – 3,110)
Change in NWC = $835
And the net capital spending was:
Net capital spending = NFAend – NFAbeg + Depreciation
Net capital spending = $22,608 – 19,872 + 3,408
Net capital spending = $6,144
So, the cash flow from assets was:
Cash flow from assets = OCF – Change in NWC – Net capital spending
Cash flow from assets = $6,566 – 835 – 6,144
Cash flow from assets = –$413
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 fixed assets and net working capital; it had to raise a net $413
in funds from its stockholders and creditors to make these investments.
Now we can use the cash flow to creditors equation to find:
Cash flow to creditors = Interest – Net new long-term debt
$130,000 = $245,000 – Net new long-term debt
Net new long-term debt = $115,000
21. a. To calculate the OCF, we first need to construct an income statement. The income statement starts
with revenues and subtracts costs to arrive at EBIT. We then subtract out interest to get taxable
income, and then subtract taxes to arrive at net income. Doing so, we get:
Income Statement
Sales $28,476
Cost of goods sold 20,136
Depreciation 3,408
EBIT $ 4,932
Interest 497
Taxable income $ 4,435
Taxes (40%) 1,774
Net income $ 2,661
b. The operating cash flow for the year was:
OCF = EBIT + Depreciation – Taxes
OCF = $4,932 + 3,408 – 1,774
OCF = $6,566
c. To calculate the cash flow from assets, we also need the change in net working capital and net
capital spending. The change in net working capital was:
Change in NWC = NWCend – NWCbeg
Change in NWC = (CAend – CLend) – (CAbeg – CLbeg)
Change in NWC = ($4,234 – 2,981) – ($3,528 – 3,110)
Change in NWC = $835
And the net capital spending was:
Net capital spending = NFAend – NFAbeg + Depreciation
Net capital spending = $22,608 – 19,872 + 3,408
Net capital spending = $6,144
So, the cash flow from assets was:
Cash flow from assets = OCF – Change in NWC – Net capital spending
Cash flow from assets = $6,566 – 835 – 6,144
Cash flow from assets = –$413
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 fixed assets and net working capital; it had to raise a net $413
in funds from its stockholders and creditors to make these investments.
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CHAPTER 2 – 14
d. The cash flow to creditors was:
Cash flow to creditors = Interest – Net new LTD
Cash flow to creditors = $497 – 0
Cash flow to creditors = $497
Rearranging the cash flow from assets equation, we can calculate the cash flow to stockholders as:
Cash flow from assets = Cash flow to stockholders + Cash flow to creditors
–$413 = Cash flow to stockholders + $497
Cash flow to stockholders = –$910
Now we can use the cash flow to stockholders equation to find the net new equity as:
Cash flow to stockholders = Dividends – Net new equity
–$910 = $739 – Net new equity
Net new equity = $1,649
The firm had positive earnings in an accounting sense (NI > 0) and had positive cash flow from
operations. The firm invested $835 in new net working capital and $6,144 in new fixed assets. The
firm had to raise $413 from its stakeholders to support this new investment. It accomplished this
by raising $1,649 in the form of new equity. After paying out $739 in the form of dividends to
shareholders and $497 in the form of interest to creditors, $413 was left to just meet the firm’s cash
flow needs for investment.
22. a. To calculate owners’ equity, we first need total liabilities and owners’ equity. From the balance
sheet relationship we know that this is equal to total assets. We are given the necessary information
to calculate total assets. Total assets are current assets plus fixed assets, so:
Total assets = Current assets + Fixed assets = Total liabilities and owners’ equity
For 2015, we get:
Total assets = $2,718 + 12,602
Total assets = $15,320
Now, we can solve for owners’ equity as:
Total liabilities and owners’ equity = Current liabilities + Long-term debt + Owners’ equity
$15,320 = $1,174 + 6,873 + Owners’ equity
Owners’ equity = $7,273
For 2016, we get:
Total assets = $2,881 + 13,175
Total assets = $16,056
d. The cash flow to creditors was:
Cash flow to creditors = Interest – Net new LTD
Cash flow to creditors = $497 – 0
Cash flow to creditors = $497
Rearranging the cash flow from assets equation, we can calculate the cash flow to stockholders as:
Cash flow from assets = Cash flow to stockholders + Cash flow to creditors
–$413 = Cash flow to stockholders + $497
Cash flow to stockholders = –$910
Now we can use the cash flow to stockholders equation to find the net new equity as:
Cash flow to stockholders = Dividends – Net new equity
–$910 = $739 – Net new equity
Net new equity = $1,649
The firm had positive earnings in an accounting sense (NI > 0) and had positive cash flow from
operations. The firm invested $835 in new net working capital and $6,144 in new fixed assets. The
firm had to raise $413 from its stakeholders to support this new investment. It accomplished this
by raising $1,649 in the form of new equity. After paying out $739 in the form of dividends to
shareholders and $497 in the form of interest to creditors, $413 was left to just meet the firm’s cash
flow needs for investment.
22. a. To calculate owners’ equity, we first need total liabilities and owners’ equity. From the balance
sheet relationship we know that this is equal to total assets. We are given the necessary information
to calculate total assets. Total assets are current assets plus fixed assets, so:
Total assets = Current assets + Fixed assets = Total liabilities and owners’ equity
For 2015, we get:
Total assets = $2,718 + 12,602
Total assets = $15,320
Now, we can solve for owners’ equity as:
Total liabilities and owners’ equity = Current liabilities + Long-term debt + Owners’ equity
$15,320 = $1,174 + 6,873 + Owners’ equity
Owners’ equity = $7,273
For 2016, we get:
Total assets = $2,881 + 13,175
Total assets = $16,056
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15 – SOLUTIONS MANUAL
Now we can solve for owners’ equity as:
Total liabilities and owners’ equity = Current liabilities + Long-term debt + Owners’ equity
$16,056 = $1,726 + 8,019 + Owners’ equity
Owners’ equity = $6,311
b. The change in net working capital was:
Change in NWC = NWCend – NWCbeg
Change in NWC = (CAend – CLend) – (CAbeg – CLbeg)
Change in NWC = ($2,881 – 1,726) – ($2,718 – 1,174)
Change in NWC = –$389
c. To find the amount of fixed assets the company sold, we need to find the net capital spending. The
net capital spending was:
Net capital spending = NFAend – NFAbeg + Depreciation
Net capital spending = $13,175 – 12,602 + 3,434
Net capital spending = $4,007
To find the fixed assets sold, we can also calculate net capital spending as:
Net capital spending = Fixed assets bought – Fixed assets sold
$4,007 = $7,160 – Fixed assets sold
Fixed assets sold = $3,153
To calculate the cash flow from assets, we first need to calculate the operating cash flow. For the
operating cash flow, we need the income statement. So, the income statement for the year is:
Income Statement
Sales $40,664
Costs 20,393
Depreciation 3,434
EBIT $16,837
Interest 638
Taxable income $16,199
Taxes (40%) 6,480
Net income $ 9,719
Now we can calculate the operating cash flow, which is:
OCF = EBIT + Depreciation – Taxes
OCF = $16,837 + 3,434 – 6,480
OCF = $13,791
And the cash flow from assets is:
Cash flow from assets = OCF – Change in NWC – Net capital spending.
Cash flow from assets = $13,791 – (–$389) – 4,007
Cash flow from assets = $10,173
Now we can solve for owners’ equity as:
Total liabilities and owners’ equity = Current liabilities + Long-term debt + Owners’ equity
$16,056 = $1,726 + 8,019 + Owners’ equity
Owners’ equity = $6,311
b. The change in net working capital was:
Change in NWC = NWCend – NWCbeg
Change in NWC = (CAend – CLend) – (CAbeg – CLbeg)
Change in NWC = ($2,881 – 1,726) – ($2,718 – 1,174)
Change in NWC = –$389
c. To find the amount of fixed assets the company sold, we need to find the net capital spending. The
net capital spending was:
Net capital spending = NFAend – NFAbeg + Depreciation
Net capital spending = $13,175 – 12,602 + 3,434
Net capital spending = $4,007
To find the fixed assets sold, we can also calculate net capital spending as:
Net capital spending = Fixed assets bought – Fixed assets sold
$4,007 = $7,160 – Fixed assets sold
Fixed assets sold = $3,153
To calculate the cash flow from assets, we first need to calculate the operating cash flow. For the
operating cash flow, we need the income statement. So, the income statement for the year is:
Income Statement
Sales $40,664
Costs 20,393
Depreciation 3,434
EBIT $16,837
Interest 638
Taxable income $16,199
Taxes (40%) 6,480
Net income $ 9,719
Now we can calculate the operating cash flow, which is:
OCF = EBIT + Depreciation – Taxes
OCF = $16,837 + 3,434 – 6,480
OCF = $13,791
And the cash flow from assets is:
Cash flow from assets = OCF – Change in NWC – Net capital spending.
Cash flow from assets = $13,791 – (–$389) – 4,007
Cash flow from assets = $10,173
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CHAPTER 2 – 16
d. To find the cash flow to creditors, we first need to find the net new borrowing. The net new
borrowing is the difference between the ending long-term debt and the beginning long-term debt,
so:
Net new borrowing = LTDEnding – LTDBeginnning
Net new borrowing = $8,019 – 6,873
Net new borrowing = $1,146
So, the cash flow to creditors is:
Cash flow to creditors = Interest – Net new borrowing
Cash flow to creditors = $638 – 1,146
Cash flow to creditors = –$508
The net new borrowing is also the difference between the debt issued and the debt retired. We know
the amount the company issued during the year, so we can find the amount the company retired.
The amount of debt retired was:
Net new borrowing = Debt issued – Debt retired
$1,146 = $2,155 – Debt retired
Debt retired = $1,009
23. To construct the cash flow identity, we will begin with cash flow from assets. Cash flow from assets
is:
Cash flow from assets = OCF – Change in NWC – Net capital spending
So, the operating cash flow is:
OCF = EBIT + Depreciation – Taxes
OCF = $103,562 + 69,038 – 27,703
OCF = $144,897
Next, we will calculate the change in net working capital, which is:
Change in NWC = NWCend – NWCbeg
Change in NWC = (CAend – CLend) – (CAbeg – CLbeg)
Change in NWC = ($73,571 – 34,127) – ($58,325 – 30,352)
Change in NWC = $11,471
Now, we can calculate the capital spending. The capital spending is:
Net capital spending = NFAend – NFAbeg + Depreciation
Net capital spending = $513,980 – 435,670 + 69,038
Net capital spending = $147,348
Now, we have the cash flow from assets, which is:
Cash flow from assets = OCF – Change in NWC – Net capital spending
Cash flow from assets = $144,897 – 11,471 – 147,348
Cash flow from assets = –$13,922
d. To find the cash flow to creditors, we first need to find the net new borrowing. The net new
borrowing is the difference between the ending long-term debt and the beginning long-term debt,
so:
Net new borrowing = LTDEnding – LTDBeginnning
Net new borrowing = $8,019 – 6,873
Net new borrowing = $1,146
So, the cash flow to creditors is:
Cash flow to creditors = Interest – Net new borrowing
Cash flow to creditors = $638 – 1,146
Cash flow to creditors = –$508
The net new borrowing is also the difference between the debt issued and the debt retired. We know
the amount the company issued during the year, so we can find the amount the company retired.
The amount of debt retired was:
Net new borrowing = Debt issued – Debt retired
$1,146 = $2,155 – Debt retired
Debt retired = $1,009
23. To construct the cash flow identity, we will begin with cash flow from assets. Cash flow from assets
is:
Cash flow from assets = OCF – Change in NWC – Net capital spending
So, the operating cash flow is:
OCF = EBIT + Depreciation – Taxes
OCF = $103,562 + 69,038 – 27,703
OCF = $144,897
Next, we will calculate the change in net working capital, which is:
Change in NWC = NWCend – NWCbeg
Change in NWC = (CAend – CLend) – (CAbeg – CLbeg)
Change in NWC = ($73,571 – 34,127) – ($58,325 – 30,352)
Change in NWC = $11,471
Now, we can calculate the capital spending. The capital spending is:
Net capital spending = NFAend – NFAbeg + Depreciation
Net capital spending = $513,980 – 435,670 + 69,038
Net capital spending = $147,348
Now, we have the cash flow from assets, which is:
Cash flow from assets = OCF – Change in NWC – Net capital spending
Cash flow from assets = $144,897 – 11,471 – 147,348
Cash flow from assets = –$13,922
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17 – SOLUTIONS MANUAL
The company’s assets generated an outflow of $13,922. The cash flow from operations was $144,897,
and the company spent $11,471 on net working capital and $147,348 on fixed assets.
The cash flow to creditors is:
Cash flow to creditors = Interest paid – New long-term debt
Cash flow to creditors = Interest paid – (Long-term debtend – Long-term debtbeg)
Cash flow to creditors = $24,410 – ($192,300 – 173,100)
Cash flow to creditors = $5,210
The cash flow to stockholders is a little trickier in this problem. First, we need to calculate the new
equity sold. The equity balance increased during the year. The only way to increase the equity balance
is retained earnings or sell equity. To calculate the new equity sold, we can use the following equation:
New equity = Ending equity – Beginning equity – Addition to retained earnings
New equity = $361,124 – 290,543 – 35,249
New equity = $35,332
What happened was the equity account increased by $70,581. Of this increase, $35,249 came from
addition to retained earnings, so the remainder must have been the sale of new equity. Now we can
calculate the cash flow to stockholders as:
Cash flow to stockholders = Dividends paid – Net new equity
Cash flow to stockholders = $16,200 – 35,332
Cash flow to stockholders = –$19,132
The company paid $5,210 to creditors and raised $19,132 from stockholders.
Finally, the cash flow identity is:
Cash flow from assets = Cash flow to creditors + Cash flow to stockholders
–$13,922 = $5,210 + –$19,132
The cash flow identity balances, which is what we expect.
Challenge
24. Net capital spending = NFAend – NFAbeg + Depreciation
= (NFAend – NFAbeg) + (Depreciation + ADbeg) – ADbeg
= (NFAend – NFAbeg)+ ADend – ADbeg
= (NFAend + ADend) – (NFAbeg + ADbeg)
= FAend – FAbeg
25. a. The tax bubble causes average tax rates to catch up to marginal tax rates, thus eliminating the tax
advantage of low marginal rates for high-income corporations.
The company’s assets generated an outflow of $13,922. The cash flow from operations was $144,897,
and the company spent $11,471 on net working capital and $147,348 on fixed assets.
The cash flow to creditors is:
Cash flow to creditors = Interest paid – New long-term debt
Cash flow to creditors = Interest paid – (Long-term debtend – Long-term debtbeg)
Cash flow to creditors = $24,410 – ($192,300 – 173,100)
Cash flow to creditors = $5,210
The cash flow to stockholders is a little trickier in this problem. First, we need to calculate the new
equity sold. The equity balance increased during the year. The only way to increase the equity balance
is retained earnings or sell equity. To calculate the new equity sold, we can use the following equation:
New equity = Ending equity – Beginning equity – Addition to retained earnings
New equity = $361,124 – 290,543 – 35,249
New equity = $35,332
What happened was the equity account increased by $70,581. Of this increase, $35,249 came from
addition to retained earnings, so the remainder must have been the sale of new equity. Now we can
calculate the cash flow to stockholders as:
Cash flow to stockholders = Dividends paid – Net new equity
Cash flow to stockholders = $16,200 – 35,332
Cash flow to stockholders = –$19,132
The company paid $5,210 to creditors and raised $19,132 from stockholders.
Finally, the cash flow identity is:
Cash flow from assets = Cash flow to creditors + Cash flow to stockholders
–$13,922 = $5,210 + –$19,132
The cash flow identity balances, which is what we expect.
Challenge
24. Net capital spending = NFAend – NFAbeg + Depreciation
= (NFAend – NFAbeg) + (Depreciation + ADbeg) – ADbeg
= (NFAend – NFAbeg)+ ADend – ADbeg
= (NFAend + ADend) – (NFAbeg + ADbeg)
= FAend – FAbeg
25. a. The tax bubble causes average tax rates to catch up to marginal tax rates, thus eliminating the tax
advantage of low marginal rates for high-income corporations.
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CHAPTER 2 – 18
b. Taxes = .15($50K) + .25($25K) + .34($25K) + .39($235K) = $113.9K
Average tax rate = $113.9K / $335K = 34%
The marginal tax rate on the next dollar of income is 34 percent.
For corporate taxable income levels of $335K to $10M, average tax rates are equal to marginal tax
rates.
Taxes = .34($10M) + .35($5M) + .38($3.333M) = $6,416,667
Average tax rate = $6,416,667 / $18,333,334 = 35%
The marginal tax rate on the next dollar of income is 35 percent. For corporate taxable income
levels over $18,333,334, average tax rates are again equal to marginal tax rates.
c. At the end of the “tax bubble”, the marginal tax rate on the next dollar should equal the average tax
rate on all preceding dollars. Since the upper threshold of the bubble bracket is now $200,000, the
marginal tax rate on dollar $200,001 should be 34 percent, and the total tax paid on the first
$200,000 should be $200,000(.34). So, we get:
Taxes = .34($200K) = $68K = .15($50K) + .25($25K) + .34($25K) + X($100K)
X($100K) = $68K – 22.25K = $45.75K
X = $45.75K / $100K
X = 45.75%
b. Taxes = .15($50K) + .25($25K) + .34($25K) + .39($235K) = $113.9K
Average tax rate = $113.9K / $335K = 34%
The marginal tax rate on the next dollar of income is 34 percent.
For corporate taxable income levels of $335K to $10M, average tax rates are equal to marginal tax
rates.
Taxes = .34($10M) + .35($5M) + .38($3.333M) = $6,416,667
Average tax rate = $6,416,667 / $18,333,334 = 35%
The marginal tax rate on the next dollar of income is 35 percent. For corporate taxable income
levels over $18,333,334, average tax rates are again equal to marginal tax rates.
c. At the end of the “tax bubble”, the marginal tax rate on the next dollar should equal the average tax
rate on all preceding dollars. Since the upper threshold of the bubble bracket is now $200,000, the
marginal tax rate on dollar $200,001 should be 34 percent, and the total tax paid on the first
$200,000 should be $200,000(.34). So, we get:
Taxes = .34($200K) = $68K = .15($50K) + .25($25K) + .34($25K) + X($100K)
X($100K) = $68K – 22.25K = $45.75K
X = $45.75K / $100K
X = 45.75%
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CHAPTER 3
WORKING WITH FINANCIAL
STATEMENTS
Answers to Concepts Review and Critical Thinking Questions
1. a. If inventory is purchased with cash, then there is no change in the current ratio. If inventory is
purchased on credit, then there is a decrease in the current ratio if it was initially greater than 1.0.
b. Reducing accounts payable with cash increases the current ratio if it was initially greater than 1.0.
c. Reducing short-term debt with cash increases the current ratio if it was initially greater than 1.0.
d. As long-term debt approaches maturity, the principal repayment and the remaining interest
expense become current liabilities. Thus, if debt is paid off with cash, the current ratio increases
if it was initially greater than 1.0. If the debt has not yet become a current liability, then paying it
off will reduce the current ratio since current liabilities are not affected.
e. Reduction of accounts receivables and an increase in cash leaves the current ratio unchanged.
f. Inventory sold at cost reduces inventory and raises cash, so the current ratio is unchanged.
g. Inventory sold for a profit raises cash in excess of the inventory recorded at cost, so the current
ratio increases.
2. The firm has increased inventory relative to other current assets; therefore, assuming current liability
levels remain mostly unchanged, liquidity has potentially decreased.
3. A current ratio of .50 means that the firm has twice as much in current liabilities as it does in current
assets; the firm potentially has poor liquidity. If pressed by its short-term creditors and suppliers for
immediate payment, the firm might have a difficult time meeting its obligations. A current ratio of
1.50 means the firm has 50% more current assets than it does current liabilities. This probably
represents an improvement in liquidity; short-term obligations can generally be met completely with
a safety factor built in. A current ratio of 15.0, however, might be excessive. Any excess funds sitting
in current assets generally earn little or no return. These excess funds might be put to better use by
investing in productive long-term assets or distributing the funds to shareholders.
4. a. Quick ratio provides a measure of the short-term liquidity of the firm, after removing the effects
of inventory, generally the least liquid of the firm’s current assets.
b. Cash ratio represents the ability of the firm to completely pay off its current liabilities balance with
its most liquid asset (cash).
c. The capital intensity ratio tells us the dollar amount investment in assets needed to generate one
dollar in sales.
WORKING WITH FINANCIAL
STATEMENTS
Answers to Concepts Review and Critical Thinking Questions
1. a. If inventory is purchased with cash, then there is no change in the current ratio. If inventory is
purchased on credit, then there is a decrease in the current ratio if it was initially greater than 1.0.
b. Reducing accounts payable with cash increases the current ratio if it was initially greater than 1.0.
c. Reducing short-term debt with cash increases the current ratio if it was initially greater than 1.0.
d. As long-term debt approaches maturity, the principal repayment and the remaining interest
expense become current liabilities. Thus, if debt is paid off with cash, the current ratio increases
if it was initially greater than 1.0. If the debt has not yet become a current liability, then paying it
off will reduce the current ratio since current liabilities are not affected.
e. Reduction of accounts receivables and an increase in cash leaves the current ratio unchanged.
f. Inventory sold at cost reduces inventory and raises cash, so the current ratio is unchanged.
g. Inventory sold for a profit raises cash in excess of the inventory recorded at cost, so the current
ratio increases.
2. The firm has increased inventory relative to other current assets; therefore, assuming current liability
levels remain mostly unchanged, liquidity has potentially decreased.
3. A current ratio of .50 means that the firm has twice as much in current liabilities as it does in current
assets; the firm potentially has poor liquidity. If pressed by its short-term creditors and suppliers for
immediate payment, the firm might have a difficult time meeting its obligations. A current ratio of
1.50 means the firm has 50% more current assets than it does current liabilities. This probably
represents an improvement in liquidity; short-term obligations can generally be met completely with
a safety factor built in. A current ratio of 15.0, however, might be excessive. Any excess funds sitting
in current assets generally earn little or no return. These excess funds might be put to better use by
investing in productive long-term assets or distributing the funds to shareholders.
4. a. Quick ratio provides a measure of the short-term liquidity of the firm, after removing the effects
of inventory, generally the least liquid of the firm’s current assets.
b. Cash ratio represents the ability of the firm to completely pay off its current liabilities balance with
its most liquid asset (cash).
c. The capital intensity ratio tells us the dollar amount investment in assets needed to generate one
dollar in sales.
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20 – SOLUTIONS
d. Total asset turnover measures how much in sales is generated by each dollar of firm assets.
e. Equity multiplier represents the degree of leverage for an equity investor of the firm; it measures
the dollar worth of firm assets each equity dollar has a claim to.
f. Times interest earned ratio provides a relative measure of how well the firm’s operating earnings
can cover current interest obligations.
g. Profit margin is the accounting measure of bottom-line profit per dollar of sales.
h. Return on assets is a measure of bottom-line profit per dollar of total assets.
i. Return on equity is a measure of bottom-line profit per dollar of equity.
j. Price–earnings ratio reflects how much value per share the market places on a dollar of accounting
earnings for a firm.
5. Common size financial statements express all balance sheet accounts as a percentage of total assets
and all income statement accounts as a percentage of total sales. Using these percentage values rather
than nominal dollar values facilitates comparisons between firms of different size or business type.
6. Peer group analysis involves comparing the financial ratios and operating performance of a particular
firm to a set of peer group firms in the same industry or line of business. Comparing a firm to its peers
allows the financial manager to evaluate whether some aspects of the firm’s operations, finances, or
investment activities are out of line with the norm, thereby providing some guidance on appropriate
actions to take to adjust these ratios, if appropriate. An aspirant group would be a set of firms whose
performance the company in question would like to emulate. The financial manager often uses the
financial ratios of aspirant groups as the target ratios for his or her firm; some managers are evaluated
by how well they match the performance of an identified aspirant group.
7. Return on equity is probably the most important accounting ratio that measures the bottom-line
performance of the firm with respect to the equity shareholders. The Du Pont identity emphasizes the
role of a firm’s profitability, asset utilization efficiency, and financial leverage in achieving a ROE
figure. For example, a firm with ROE of 20% would seem to be doing well, but this figure may be
misleading if it were a marginally profitable (low profit margin) and highly levered (high equity
multiplier). If the firm’s margins were to erode slightly, the ROE would be heavily impacted.
8. The book-to-bill ratio is intended to measure whether demand is growing or falling. It is closely
followed because it is a barometer for the entire high-tech industry where levels of revenues and
earnings have been relatively volatile.
9. If a company is growing by opening new stores, then presumably total revenues would be rising.
Comparing total sales at two different points in time might be misleading. Same-store sales control for
this by only looking at revenues of stores open within a specific period.
d. Total asset turnover measures how much in sales is generated by each dollar of firm assets.
e. Equity multiplier represents the degree of leverage for an equity investor of the firm; it measures
the dollar worth of firm assets each equity dollar has a claim to.
f. Times interest earned ratio provides a relative measure of how well the firm’s operating earnings
can cover current interest obligations.
g. Profit margin is the accounting measure of bottom-line profit per dollar of sales.
h. Return on assets is a measure of bottom-line profit per dollar of total assets.
i. Return on equity is a measure of bottom-line profit per dollar of equity.
j. Price–earnings ratio reflects how much value per share the market places on a dollar of accounting
earnings for a firm.
5. Common size financial statements express all balance sheet accounts as a percentage of total assets
and all income statement accounts as a percentage of total sales. Using these percentage values rather
than nominal dollar values facilitates comparisons between firms of different size or business type.
6. Peer group analysis involves comparing the financial ratios and operating performance of a particular
firm to a set of peer group firms in the same industry or line of business. Comparing a firm to its peers
allows the financial manager to evaluate whether some aspects of the firm’s operations, finances, or
investment activities are out of line with the norm, thereby providing some guidance on appropriate
actions to take to adjust these ratios, if appropriate. An aspirant group would be a set of firms whose
performance the company in question would like to emulate. The financial manager often uses the
financial ratios of aspirant groups as the target ratios for his or her firm; some managers are evaluated
by how well they match the performance of an identified aspirant group.
7. Return on equity is probably the most important accounting ratio that measures the bottom-line
performance of the firm with respect to the equity shareholders. The Du Pont identity emphasizes the
role of a firm’s profitability, asset utilization efficiency, and financial leverage in achieving a ROE
figure. For example, a firm with ROE of 20% would seem to be doing well, but this figure may be
misleading if it were a marginally profitable (low profit margin) and highly levered (high equity
multiplier). If the firm’s margins were to erode slightly, the ROE would be heavily impacted.
8. The book-to-bill ratio is intended to measure whether demand is growing or falling. It is closely
followed because it is a barometer for the entire high-tech industry where levels of revenues and
earnings have been relatively volatile.
9. If a company is growing by opening new stores, then presumably total revenues would be rising.
Comparing total sales at two different points in time might be misleading. Same-store sales control for
this by only looking at revenues of stores open within a specific period.
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CHAPTER 3 – 21
10. a. For an electric utility such as Con Ed, expressing costs on a per kilowatt-hour basis would be a
way of comparing costs with other utilities of different sizes.
b. For a retailer such as JC Penney, expressing sales on a per square foot basis would be useful in
comparing revenue production against other retailers.
c. For an airline such as Delta, expressing costs on a per passenger mile basis allows for
comparisons with other airlines by examining how much it costs to fly one passenger one mile.
d. For an on-line service such as Google or Yahoo!, using a per web hit basis for costs would allow
for comparisons with similar services.
e. For a hospital such as Holy Cross, revenues and costs expressed on a per bed basis would be
useful.
f. For a college textbook publisher such as McGraw-Hill Higher Education, the leading publisher
of finance textbooks for the college market, the obvious standardization would be per book sold.
11. As with any ratio analysis, the ratios themselves do not necessarily indicate a problem, but simply
indicate that something is different and it is up to us to determine if a problem exists. If the cost of
goods sold as a percentage of sales is increasing, we would expect that EBIT as a percentage of sales
would decrease, all else constant. An increase in the cost of goods sold as a percentage of sales occurs
because the cost of raw materials or other inventory is increasing at a faster rate than the sales price.
This may be a bad sign since the contribution of each sales dollar to net income and cash flow is lower.
However, when a new product, for example, the HDTV, enters the market, the price of one unit will
often be high relative to the cost of goods sold per unit, and demand, therefore sales, initially small.
As the product market becomes more developed, price of the product generally drops, and sales
increase as more competition enters the market. In this case, the increase in cost of goods sold as a
percentage of sales is to be expected. The maker or seller expects to boost sales at a faster rate than its
cost of goods sold increases. In this case, a good practice would be to examine the common-size
income statements to see if this is an industry-wide occurrence.
12. If we assume that the cause is negative, the two reasons for the trend of increasing cost of goods sold
as a percentage of sales are that costs are becoming too high or the sales price is not increasing fast
enough. If the cause is an increase in the cost of goods sold, the manager should look at possible
actions to control costs. If costs can be lowered by seeking lower cost suppliers of similar or higher
quality, the cost of goods sold as a percentage of sales should decrease. Another alternative is to
increase the sales price to cover the increase in the cost of goods sold. Depending on the industry, this
may be difficult or impossible. For example, if the company sells most of its products under a long-
term contract that has a fixed price, it may not be able to increase the sales price and will be forced to
look for other cost-cutting possibilities. Additionally, if the market is competitive, the company might
also be unable to increase the sales price.
10. a. For an electric utility such as Con Ed, expressing costs on a per kilowatt-hour basis would be a
way of comparing costs with other utilities of different sizes.
b. For a retailer such as JC Penney, expressing sales on a per square foot basis would be useful in
comparing revenue production against other retailers.
c. For an airline such as Delta, expressing costs on a per passenger mile basis allows for
comparisons with other airlines by examining how much it costs to fly one passenger one mile.
d. For an on-line service such as Google or Yahoo!, using a per web hit basis for costs would allow
for comparisons with similar services.
e. For a hospital such as Holy Cross, revenues and costs expressed on a per bed basis would be
useful.
f. For a college textbook publisher such as McGraw-Hill Higher Education, the leading publisher
of finance textbooks for the college market, the obvious standardization would be per book sold.
11. As with any ratio analysis, the ratios themselves do not necessarily indicate a problem, but simply
indicate that something is different and it is up to us to determine if a problem exists. If the cost of
goods sold as a percentage of sales is increasing, we would expect that EBIT as a percentage of sales
would decrease, all else constant. An increase in the cost of goods sold as a percentage of sales occurs
because the cost of raw materials or other inventory is increasing at a faster rate than the sales price.
This may be a bad sign since the contribution of each sales dollar to net income and cash flow is lower.
However, when a new product, for example, the HDTV, enters the market, the price of one unit will
often be high relative to the cost of goods sold per unit, and demand, therefore sales, initially small.
As the product market becomes more developed, price of the product generally drops, and sales
increase as more competition enters the market. In this case, the increase in cost of goods sold as a
percentage of sales is to be expected. The maker or seller expects to boost sales at a faster rate than its
cost of goods sold increases. In this case, a good practice would be to examine the common-size
income statements to see if this is an industry-wide occurrence.
12. If we assume that the cause is negative, the two reasons for the trend of increasing cost of goods sold
as a percentage of sales are that costs are becoming too high or the sales price is not increasing fast
enough. If the cause is an increase in the cost of goods sold, the manager should look at possible
actions to control costs. If costs can be lowered by seeking lower cost suppliers of similar or higher
quality, the cost of goods sold as a percentage of sales should decrease. Another alternative is to
increase the sales price to cover the increase in the cost of goods sold. Depending on the industry, this
may be difficult or impossible. For example, if the company sells most of its products under a long-
term contract that has a fixed price, it may not be able to increase the sales price and will be forced to
look for other cost-cutting possibilities. Additionally, if the market is competitive, the company might
also be unable to increase the sales price.
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22 – SOLUTIONS
Solutions to Questions and Problems
NOTE: All end-of-chapter problems were solved using a spreadsheet. Many problems require multiple
steps. Due to space and readability constraints, when these intermediate steps are included in this solutions
manual, rounding may appear to have occurred. However, the final answer for each problem is found
without rounding during any step in the problem.
Basic
1. To find the current assets, we must use the net working capital equation. Doing so, we find:
NWC = Current assets – Current liabilities
$1,965 = Current assets – $5,460
Current assets = $7,425
Now, use this number to calculate the current ratio and the quick ratio. The current ratio is:
Current ratio = Current assets / Current liabilities
Current ratio = $7,425 / $5,460
Current ratio = 1.36 times
And the quick ratio is:
Quick ratio = (Current assets – Inventory) / Current liabilities
Quick ratio = ($7,425 – 2,170) / $5,460
Quick ratio = .96 times
2. To find the return on assets and return on equity, we need net income. We can calculate the net income
using the profit margin. Doing so, we find the net income is:
Profit margin = Net income / Sales
.07 = Net income / $13,500,000
Net income = $945,000
Now we can calculate the return on assets as:
ROA = Net income / Total assets
ROA = $945,000 / $8,700,000
ROA = .1086, or 10.86%
We do not have the equity for the company, but we know that equity must be equal to total assets
minus total debt, so the ROE is:
ROE = Net income / (Total assets – Total debt)
ROE = $945,000 / ($8,700,000 – 4,100,000)
ROE = .2054, or 20.54%
Solutions to Questions and Problems
NOTE: All end-of-chapter problems were solved using a spreadsheet. Many problems require multiple
steps. Due to space and readability constraints, when these intermediate steps are included in this solutions
manual, rounding may appear to have occurred. However, the final answer for each problem is found
without rounding during any step in the problem.
Basic
1. To find the current assets, we must use the net working capital equation. Doing so, we find:
NWC = Current assets – Current liabilities
$1,965 = Current assets – $5,460
Current assets = $7,425
Now, use this number to calculate the current ratio and the quick ratio. The current ratio is:
Current ratio = Current assets / Current liabilities
Current ratio = $7,425 / $5,460
Current ratio = 1.36 times
And the quick ratio is:
Quick ratio = (Current assets – Inventory) / Current liabilities
Quick ratio = ($7,425 – 2,170) / $5,460
Quick ratio = .96 times
2. To find the return on assets and return on equity, we need net income. We can calculate the net income
using the profit margin. Doing so, we find the net income is:
Profit margin = Net income / Sales
.07 = Net income / $13,500,000
Net income = $945,000
Now we can calculate the return on assets as:
ROA = Net income / Total assets
ROA = $945,000 / $8,700,000
ROA = .1086, or 10.86%
We do not have the equity for the company, but we know that equity must be equal to total assets
minus total debt, so the ROE is:
ROE = Net income / (Total assets – Total debt)
ROE = $945,000 / ($8,700,000 – 4,100,000)
ROE = .2054, or 20.54%
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CHAPTER 3 – 23
3. The receivables turnover for the company was:
Receivables turnover = Credit sales / Receivables
Receivables turnover = $6,787,626 / $583,174
Receivables turnover = 11.64 times
Using the receivables turnover, we can calculate the days’ sales in receivables as:
Days’ sales in receivables = 365 days / Receivables turnover
Days’ sales in receivables = 365 days / 11.64
Days’ sales in receivables = 31.36 days
The average collection period, which is the same as the days’ sales in receivables, was 31.36 days.
4. The inventory turnover for the company was:
Inventory turnover = COGS / Inventory
Inventory turnover = $8,543,132 / $527,156
Inventory turnover = 16.21 times
Using the inventory turnover, we can calculate the days’ sales in inventory as:
Days’ sales in inventory = 365 days / Inventory turnover
Days’ sales in inventory = 365 days / 16.21
Days’ sales in inventory = 22.52 days
On average, a unit of inventory sat on the shelf 22.52 days before it was sold.
5. To find the debt–equity ratio using the total debt ratio, we need to rearrange the total debt ratio
equation. We must realize that the total assets are equal to total debt plus total equity. Doing so, we
find:
Total debt ratio = Total debt / Total assets
.19 = Total debt / (Total debt + Total equity)
.81(Total debt) = .19(Total equity)
Total debt / Total equity = .19 / .81
Debt–equity ratio = .23
And the equity multiplier is one plus the debt–equity ratio, so:
Equity multiplier = 1 + D/E
Equity multiplier = 1 + .23
Equity multiplier = 1.23
3. The receivables turnover for the company was:
Receivables turnover = Credit sales / Receivables
Receivables turnover = $6,787,626 / $583,174
Receivables turnover = 11.64 times
Using the receivables turnover, we can calculate the days’ sales in receivables as:
Days’ sales in receivables = 365 days / Receivables turnover
Days’ sales in receivables = 365 days / 11.64
Days’ sales in receivables = 31.36 days
The average collection period, which is the same as the days’ sales in receivables, was 31.36 days.
4. The inventory turnover for the company was:
Inventory turnover = COGS / Inventory
Inventory turnover = $8,543,132 / $527,156
Inventory turnover = 16.21 times
Using the inventory turnover, we can calculate the days’ sales in inventory as:
Days’ sales in inventory = 365 days / Inventory turnover
Days’ sales in inventory = 365 days / 16.21
Days’ sales in inventory = 22.52 days
On average, a unit of inventory sat on the shelf 22.52 days before it was sold.
5. To find the debt–equity ratio using the total debt ratio, we need to rearrange the total debt ratio
equation. We must realize that the total assets are equal to total debt plus total equity. Doing so, we
find:
Total debt ratio = Total debt / Total assets
.19 = Total debt / (Total debt + Total equity)
.81(Total debt) = .19(Total equity)
Total debt / Total equity = .19 / .81
Debt–equity ratio = .23
And the equity multiplier is one plus the debt–equity ratio, so:
Equity multiplier = 1 + D/E
Equity multiplier = 1 + .23
Equity multiplier = 1.23
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24 – SOLUTIONS
6. We need to calculate the net income before we calculate the earnings per share. The sum of dividends
and addition to retained earnings must equal net income, so net income must have been:
Net income = Addition to retained earnings + Dividends
Net income = $534,000 + 185,000
Net income = $719,000
So, the earnings per share were:
EPS = Net income / Shares outstanding
EPS = $719,000 / 365,000
EPS = $1.97 per share
The dividends per share were:
Dividends per share = Total dividends / Shares outstanding
Dividends per share = $185,000 / 365,000
Dividends per share = $.51 per share
The book value per share was:
Book value per share = Total equity / Shares outstanding
Book value per share = $7,450,000 / 365,000
Book value per share = $20.41 per share
The market-to-book ratio is:
Market-to-book ratio = Share price / Book value per share
Market-to-book ratio = $49 / $20.41
Market-to-book ratio = 2.40 times
The PE ratio is:
PE ratio = Share price / EPS
PE ratio = $49 / $1.97
PE ratio = 24.87 times
Sales per share are:
Sales per share = Total sales / Shares outstanding
Sales per share = $15,400,000 / 365,000
Sales per share = $42.19
The P/S ratio is:
P/S ratio = Share price / Sales per share
P/S ratio = $49 / $42.19
P/S ratio = 1.16 times
6. We need to calculate the net income before we calculate the earnings per share. The sum of dividends
and addition to retained earnings must equal net income, so net income must have been:
Net income = Addition to retained earnings + Dividends
Net income = $534,000 + 185,000
Net income = $719,000
So, the earnings per share were:
EPS = Net income / Shares outstanding
EPS = $719,000 / 365,000
EPS = $1.97 per share
The dividends per share were:
Dividends per share = Total dividends / Shares outstanding
Dividends per share = $185,000 / 365,000
Dividends per share = $.51 per share
The book value per share was:
Book value per share = Total equity / Shares outstanding
Book value per share = $7,450,000 / 365,000
Book value per share = $20.41 per share
The market-to-book ratio is:
Market-to-book ratio = Share price / Book value per share
Market-to-book ratio = $49 / $20.41
Market-to-book ratio = 2.40 times
The PE ratio is:
PE ratio = Share price / EPS
PE ratio = $49 / $1.97
PE ratio = 24.87 times
Sales per share are:
Sales per share = Total sales / Shares outstanding
Sales per share = $15,400,000 / 365,000
Sales per share = $42.19
The P/S ratio is:
P/S ratio = Share price / Sales per share
P/S ratio = $49 / $42.19
P/S ratio = 1.16 times
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CHAPTER 3 – 25
7. With the information given, we must use the Du Pont identity to calculate return on equity. Doing so,
we find:
ROE = (Profit margin)(Total asset turnover)(Equity multiplier)
ROE = (.052)(1.65)(1.83)
ROE = .1570, or 15.70%
8. We can use the Du Pont identity and solve for the equity multiplier. With the equity multiplier we can
find the debt–equity ratio. Doing so we find:
ROE = (Profit margin)(Total asset turnover)(Equity multiplier)
.1720 = (.076)(1.73)(Equity multiplier)
Equity multiplier = 1.31
Now, using the equation for the equity multiplier, we get:
Equity multiplier = 1 + Debt–equity ratio
1.31 = 1 + Debt–equity ratio
Debt–equity ratio = .31
9. To find the days’ sales in payables, we first need to find the payables turnover. The payables turnover
was:
Payables turnover = Cost of goods sold / Payables balance
Payables turnover = $87,386 / $19,472
Payables turnover = 4.49 times
Now, we can use the payables turnover to find the days’ sales in payables as:
Days’ sales in payables = 365 days / Payables turnover
Days’ sales in payables = 365 days / 4.49
Days’ sales in payables = 81.33 days
The company left its bills to suppliers outstanding for 81.33 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.
10. With the information provided, we need to calculate the return on equity using an extended return on
equity equation. We first need to find the equity multiplier, which is:
Equity multiplier = 1 + Debt–equity ratio
Equity multiplier = 1 + .75
Equity multiplier = 1.75
7. With the information given, we must use the Du Pont identity to calculate return on equity. Doing so,
we find:
ROE = (Profit margin)(Total asset turnover)(Equity multiplier)
ROE = (.052)(1.65)(1.83)
ROE = .1570, or 15.70%
8. We can use the Du Pont identity and solve for the equity multiplier. With the equity multiplier we can
find the debt–equity ratio. Doing so we find:
ROE = (Profit margin)(Total asset turnover)(Equity multiplier)
.1720 = (.076)(1.73)(Equity multiplier)
Equity multiplier = 1.31
Now, using the equation for the equity multiplier, we get:
Equity multiplier = 1 + Debt–equity ratio
1.31 = 1 + Debt–equity ratio
Debt–equity ratio = .31
9. To find the days’ sales in payables, we first need to find the payables turnover. The payables turnover
was:
Payables turnover = Cost of goods sold / Payables balance
Payables turnover = $87,386 / $19,472
Payables turnover = 4.49 times
Now, we can use the payables turnover to find the days’ sales in payables as:
Days’ sales in payables = 365 days / Payables turnover
Days’ sales in payables = 365 days / 4.49
Days’ sales in payables = 81.33 days
The company left its bills to suppliers outstanding for 81.33 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.
10. With the information provided, we need to calculate the return on equity using an extended return on
equity equation. We first need to find the equity multiplier, which is:
Equity multiplier = 1 + Debt–equity ratio
Equity multiplier = 1 + .75
Equity multiplier = 1.75
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26 – SOLUTIONS
Now we can calculate the return on equity as:
ROE = (ROA)(Equity multiplier)
ROE = .069(1.75)
ROE = .1208, or 12.08%
The return on equity equation we used was an abbreviated version of the Du Pont identity. If we
multiply the profit margin and total asset turnover ratios from the Du Pont identity, we get:
(Net income / Sales)(Sales / Total assets) = Net income / Total assets = ROA
With the return on equity, we can calculate the net income as:
ROE = Net income / Total equity
.1208 = Net income / $815,000
Net income = $98,411
11. To find the internal growth rate, we need the plowback, or retention, ratio. The plowback ratio is:
b = 1 – .25
b = .75
Now, we can use the internal growth rate equation to find:
Internal growth rate = [(ROA)(b)] / [1 – (ROA)(b)]
Internal growth rate = [.072(.75)] / [1 – .072(.75)]
Internal growth rate = .0571, or 5.71%
12. To find the sustainable growth rate we need the plowback, or retention, ratio. The plowback ratio is:
b = 1 – .20
b = .80
Now, we can use the sustainable growth rate equation to find:
Sustainable growth rate = [(ROE)(b)] / [1 – (ROE)(b)]
Sustainable growth rate = [.168(.80)] / [1 – .168(.80)]
Sustainable growth rate = .1553, or 15.53%
13. We need the return on equity to calculate the sustainable growth rate. To calculate return on equity,
we need to realize that the total asset turnover is the inverse of the capital intensity ratio and the equity
multiplier is one plus the debt–equity ratio. So, the return on equity is:
ROE = (Profit margin)(Total asset turnover)(Equity multiplier)
ROE = (.081)(1/.45)(1 + .55)
ROE = .2790, or 27.90%
Now we can calculate the return on equity as:
ROE = (ROA)(Equity multiplier)
ROE = .069(1.75)
ROE = .1208, or 12.08%
The return on equity equation we used was an abbreviated version of the Du Pont identity. If we
multiply the profit margin and total asset turnover ratios from the Du Pont identity, we get:
(Net income / Sales)(Sales / Total assets) = Net income / Total assets = ROA
With the return on equity, we can calculate the net income as:
ROE = Net income / Total equity
.1208 = Net income / $815,000
Net income = $98,411
11. To find the internal growth rate, we need the plowback, or retention, ratio. The plowback ratio is:
b = 1 – .25
b = .75
Now, we can use the internal growth rate equation to find:
Internal growth rate = [(ROA)(b)] / [1 – (ROA)(b)]
Internal growth rate = [.072(.75)] / [1 – .072(.75)]
Internal growth rate = .0571, or 5.71%
12. To find the sustainable growth rate we need the plowback, or retention, ratio. The plowback ratio is:
b = 1 – .20
b = .80
Now, we can use the sustainable growth rate equation to find:
Sustainable growth rate = [(ROE)(b)] / [1 – (ROE)(b)]
Sustainable growth rate = [.168(.80)] / [1 – .168(.80)]
Sustainable growth rate = .1553, or 15.53%
13. We need the return on equity to calculate the sustainable growth rate. To calculate return on equity,
we need to realize that the total asset turnover is the inverse of the capital intensity ratio and the equity
multiplier is one plus the debt–equity ratio. So, the return on equity is:
ROE = (Profit margin)(Total asset turnover)(Equity multiplier)
ROE = (.081)(1/.45)(1 + .55)
ROE = .2790, or 27.90%
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CHAPTER 3 – 27
Next we need the plowback ratio. The plowback ratio is one minus the payout ratio. We can calculate
the payout ratio as the dividends divided by net income, so the plowback ratio is:
b = 1 – ($65,000 / $120,000)
b = .46
Now we can use the sustainable growth rate equation to find:
Sustainable growth rate = [(ROE)(b)] / [1 – (ROE)(b)]
Sustainable growth rate = [.2790(.46)] / [1 – .2790(.46)]
Sustainable growth rate = .1466, or 14.66%
14. We need the return on equity to calculate the sustainable growth rate. Using the Du Pont identity, the
return on equity is:
ROE = (Profit margin)(Total asset turnover)(Equity multiplier)
ROE = (.057)(2.80)(1.47)
ROE = .2346, or 23.46%
To find the sustainable growth rate, we need the plowback, or retention, ratio. The plowback ratio is:
b = 1 – .55
b = .45
Now, we can use the sustainable growth rate equation to find:
Sustainable growth rate = [(ROE)(b)] / [1 – (ROE)(b)]
Sustainable growth rate = [.2346(.45)] / [1 – .2346(.45)]
Sustainable growth rate = .1180, or 11.80%
15. To calculate the common-size balance sheet, we divide each asset account by total assets, and each
liability and equity account by total liabilities and equity. For example, the common-size cash
percentage for 2015 is:
Cash percentage = Cash / Total assets
Cash percentage = $19,256 / $880,664
Cash percentage = .0219, or 2.19%
Next we need the plowback ratio. The plowback ratio is one minus the payout ratio. We can calculate
the payout ratio as the dividends divided by net income, so the plowback ratio is:
b = 1 – ($65,000 / $120,000)
b = .46
Now we can use the sustainable growth rate equation to find:
Sustainable growth rate = [(ROE)(b)] / [1 – (ROE)(b)]
Sustainable growth rate = [.2790(.46)] / [1 – .2790(.46)]
Sustainable growth rate = .1466, or 14.66%
14. We need the return on equity to calculate the sustainable growth rate. Using the Du Pont identity, the
return on equity is:
ROE = (Profit margin)(Total asset turnover)(Equity multiplier)
ROE = (.057)(2.80)(1.47)
ROE = .2346, or 23.46%
To find the sustainable growth rate, we need the plowback, or retention, ratio. The plowback ratio is:
b = 1 – .55
b = .45
Now, we can use the sustainable growth rate equation to find:
Sustainable growth rate = [(ROE)(b)] / [1 – (ROE)(b)]
Sustainable growth rate = [.2346(.45)] / [1 – .2346(.45)]
Sustainable growth rate = .1180, or 11.80%
15. To calculate the common-size balance sheet, we divide each asset account by total assets, and each
liability and equity account by total liabilities and equity. For example, the common-size cash
percentage for 2015 is:
Cash percentage = Cash / Total assets
Cash percentage = $19,256 / $880,664
Cash percentage = .0219, or 2.19%
Loading page 29...
28 – SOLUTIONS
Repeating this procedure for each account, we get:
2015 2016
Assets
Current assets
Cash $19,256 2.19% $21,946 2.21%
Accounts receivable 46,396 5.27% 54,486 5.50%
Inventory 109,626 12.45% 129,253 13.04%
Total $175,278 19.90% $205,685 20.76%
Fixed assets
Net plant and equipment $705,386 80.10% $785,205 79.24%
Total assets $880,664 100% $990,890 100%
Liabilities and owners' equity
Current liabilities
Accounts payable $171,531 19.48% $153,984 15.54%
Notes payable 79,218 9.00% 107,606 10.86%
Total $250,749 28.47% $261,590 26.40%
Long-term debt $255,000 28.96% $278,500 28.11%
Owners' equity
Common stock and paid-in
surplus $160,000 18.17% $170,000 17.16%
Accumulated retained earnings 214,915 24.40% 280,800 28.34%
Total $374,915 42.57% $450,800 45.49%
Total liabilities and owners' equity $880,664 100% $990,890 100%
16. a. The current ratio is calculated as:
Curent ratio = Current assets / Current liabilities
Current ratio2015 = $175,278 / $250,749
Current ratio2015 = .70 times
Current ratio2016 = $205,685 / $261,590
Current ratio2016 = .79 times
Repeating this procedure for each account, we get:
2015 2016
Assets
Current assets
Cash $19,256 2.19% $21,946 2.21%
Accounts receivable 46,396 5.27% 54,486 5.50%
Inventory 109,626 12.45% 129,253 13.04%
Total $175,278 19.90% $205,685 20.76%
Fixed assets
Net plant and equipment $705,386 80.10% $785,205 79.24%
Total assets $880,664 100% $990,890 100%
Liabilities and owners' equity
Current liabilities
Accounts payable $171,531 19.48% $153,984 15.54%
Notes payable 79,218 9.00% 107,606 10.86%
Total $250,749 28.47% $261,590 26.40%
Long-term debt $255,000 28.96% $278,500 28.11%
Owners' equity
Common stock and paid-in
surplus $160,000 18.17% $170,000 17.16%
Accumulated retained earnings 214,915 24.40% 280,800 28.34%
Total $374,915 42.57% $450,800 45.49%
Total liabilities and owners' equity $880,664 100% $990,890 100%
16. a. The current ratio is calculated as:
Curent ratio = Current assets / Current liabilities
Current ratio2015 = $175,278 / $250,749
Current ratio2015 = .70 times
Current ratio2016 = $205,685 / $261,590
Current ratio2016 = .79 times
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CHAPTER 3 – 29
b. The quick ratio is calculated as:
Quick ratio = (Current assets – Inventory) / Current liabilities
Quick ratio2015 = ($175,278 – 109,626) / $250,749
Quick ratio2015 = .26 times
Quick ratio2016 = ($205,685 – 129,253) / $261,590
Quick ratio2016 = .29 times
c. The cash ratio is calculated as:
Cash ratio = Cash / Current liabilities
Cash ratio2015 = $19,256 / $250,749
Cash ratio2015 = .08 times
Cash ratio2016 = $21,946 / $261,590
Cash ratio2016 = .08 times
d. The debt–equity ratio is calculated as:
Debt–equity ratio = Total debt / Total equity
Debt–equity ratio = (Current liabilities + Long-term debt) / Total equity
Debt–equity ratio2015 = ($250,749 + 255,000) / $374,915
Debt–equity ratio2015 = 1.35 times
Debt–equity ratio2016 = ($261,590 + 278,500) / $450,800
Debt–equity ratio2016 = 1.20 times
And the equity multiplier is:
Equity multiplier = 1 + Debt–equity ratio
Equity multiplier2015 = 1 + 1.35
Equity multiplier2015 = 2.35 times
Equity multiplier2016 = 1 + 1.20
Equity multiplier2016 = 2.20 times
e. The total debt ratio is calculated as:
Total debt ratio = Total debt / Total assets
Total debt ratio = (Current liabilities + Long-term debt) / Total assets
Total debt ratio2015 = ($250,749 + 255,000) / $880,664
Total debt ratio2015 = .57 times
b. The quick ratio is calculated as:
Quick ratio = (Current assets – Inventory) / Current liabilities
Quick ratio2015 = ($175,278 – 109,626) / $250,749
Quick ratio2015 = .26 times
Quick ratio2016 = ($205,685 – 129,253) / $261,590
Quick ratio2016 = .29 times
c. The cash ratio is calculated as:
Cash ratio = Cash / Current liabilities
Cash ratio2015 = $19,256 / $250,749
Cash ratio2015 = .08 times
Cash ratio2016 = $21,946 / $261,590
Cash ratio2016 = .08 times
d. The debt–equity ratio is calculated as:
Debt–equity ratio = Total debt / Total equity
Debt–equity ratio = (Current liabilities + Long-term debt) / Total equity
Debt–equity ratio2015 = ($250,749 + 255,000) / $374,915
Debt–equity ratio2015 = 1.35 times
Debt–equity ratio2016 = ($261,590 + 278,500) / $450,800
Debt–equity ratio2016 = 1.20 times
And the equity multiplier is:
Equity multiplier = 1 + Debt–equity ratio
Equity multiplier2015 = 1 + 1.35
Equity multiplier2015 = 2.35 times
Equity multiplier2016 = 1 + 1.20
Equity multiplier2016 = 2.20 times
e. The total debt ratio is calculated as:
Total debt ratio = Total debt / Total assets
Total debt ratio = (Current liabilities + Long-term debt) / Total assets
Total debt ratio2015 = ($250,749 + 255,000) / $880,664
Total debt ratio2015 = .57 times
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