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Financial Analysis

Part One – Accounting Principles and Practices

Sections 3.1, 4.3 (to page 119) and 4.1

Goals

• Describe the three primary financial goals of business

• Identify the characteristics of effective financial goals

• Describe the primary responsibility of the financial manager

• Explain the structure of financial management within an organization

• Differentiate between accounting and finance

• Know the basic accounting equation

• Understand how business transactions affect the accounting equation

• Explain the accounting cycle

• Recognize assumptions, principles, and professional practices that guide accountants’ work

Vocabulary

Creditor

Principal

Interest

Collateral

SMART goals

Accounting

GAAP

FASB

Creditor

Principal

Money and capital markets

Investments

Financial management

Equities

Accounting equation

Assets

Liabilities

Owner’s Equity

Accounts

Transactions

Entries

Source documents

Journals

Accounting cycle

Trial balance

Fiscal year

Accounting assumptions

Single economic entity

Going concern

Monetary unit

Periodic reporting

Accounting principles

Historical costs

Revenue recognition

Expense and revenue Matching

Full Disclosure

Standard Practice and Conservation

Professional Practices

Due care

Information system

Information integrity

Annual report

Sarbanes-Oxley Act

Section 3.1 Business Financial Goals

Section 4.3 Financial Management Structure

1) Main Financial Needs

A. Meet financial ____________________________ and pay its _________________.

B. Provide a competitive ___________________ for investors.

C. Finance future _______________ and _______________________ to remain competitive.

2) Characteristics of Effective Goals

A. Specific:

B. Measurable:

C. Attainable/Realistic:

D. Results-Oriented:

E. Time Bound:

3) Main Goal of Financial Management: maximize ___________________________ wealth.

4) Financial Management Decisions

A. Asset Planning:

B. Asset Financing:

C. Asset Management:

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Section 4.1 Financial and Accounting

Finance Accounting

The Accounting Equation

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1) Accounting Assumptions

A. Single Economic Entity

B. Going Concern

C. Monetary Unit

D. Periodic Reporting

2) Accounting Principles

A. Historical Costs

B. Revenue Recognition

C. (Expense & Revenue) Matching

D. Full Disclosure

E. Standard Practice

F. Conservatism

3) Professional Practice

A. Competence

B. Due Care & Sufficient Data

C. Independence & Integrity

Section 3.1 Homework

1) Textbook page 71 – Questions 1-5

1) How does the sale of products and services by the business provide money to finance operations?

2) Why are the shareholders of closely-held corporations more likely to accept a lower rate of return than shareholders in large corporations?

3) What is the difference between growth and improvement?

4) Is it possible for a business to grow and not improve or to improve but not grow? Explain.

5) What three options do businesses have to finance growth?

6) What compensations do businesses with poor finances often need to make in order to obtain financing?

7) Reword the following goal so that it meets the SMART criteria: To provide an adequate investor return.

8) Under what situations might a company want to focus on meeting current financial obligations?

9) What major financial decision must a company focused on growth make?

10) What can a company do to attract more investors?

11) Textbook page 96 – Questions 16-19

Section 4.3 Homework

12) Textbook page 123 – Questions 1-4, 8

13) Why do companies make investments?

14) How do financial managers determine which assets to purchase?

15) Why are mergers and acquisitions considered part of asset planning?

16) How is a trade credit different from an operating loan?

17) What types of activities are involved in managing fixed assets?

18) What might happen if a company has too many fixed assets and not enough liquid assets? too many liquid assets and not enough fixed assets?

19) Textbook page 136 – Question 18

Section 4.1 Homework

20) Textbook page 109 – Questions 1-5

21) What are the three interrelated areas of finance?

22) How are GAAP and the FASB related to the accounting principle of standard practices?

23) What two items make up the equity of a business?

24) How do accounts help financial managers make decisions?

25) What form is used to record transactions?

26) What is a fiscal year?

27) What is the purpose of a trial balance?

28) Why do accountants have to make adjusting entries?

29) What is the purpose of closing entries?

30) Textbook page 136 – Questions 15-17, 20

31) Identify each account as an Asset (A), Liability (L), Owner’s Equity (OE), Revenue (R) or Expense (E).

A. Accounts Payable

B. Accounts Receivable

C. Administrative Expense

D. Buildings

E. Cash

F. Common Stock

G. Equipment

H. General Expense

I. Interest Expense

J. Inventories

K. Land

L. Long-Term Debts

M. Machinery

N. Marketable Securities

O. Notes Payable

P. Operating Expense

Q. Preferred Stock

R. Retained Earnings

S. Sales Revenue

T. Selling Expense

U. Taxes

V. Vehicles

Section 4.2 Independent Section

32) Read the section and answer the checkpoint questions on pages 111, 114, and 116 (questions 1-5 only).

33) Read page 115. How did the Sarbanes-Oxley Act restore investor confidence?

Financial Analysis

Part Two – Financial Statement Preparation

Sections 3.2 and 4.3 (pages 119-122)

Goals

• State the purpose of the income statement, statement of retained earnings, balance sheet and cash flow statement

• Be able to prepare an income statement, statement of retained earnings, balance sheet and cash flow statement

Vocabulary

Financial statements

Understandable

Reliable

Comparable

Balance sheet

Current assets

Receivables

Long-term assets

Depreciation

Current liabilities

Payables

Long-term liabilities

Retained Earnings

Paid-in capital in excess of par

Working capital

Income statement

Revenue

Cost of Revenue

Gross Profit/Income

Operating Expenses

Net Profit/Income

Cash flow statement

Cash receipts

Cash payments

Solvency

Cash from operating activities

Cash from investing activities

Cash from financing activities

Section 3.2 Accounting Statements

|A. Income Statement Preparation |

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|Purpose of the Statement: |

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|Use the form below to prepare an income statement for Shutterbug Cameras for the year ended June 30. Shutterbug pays an average tax rate of 30%. During the |

|year Shutterbug Cameras recorded sales revenue of $127,151. Shutterbug paid for the following: |

| |Advertising | $ 2,380 | | |

| |Maintenance | $ 1,950 | | |

| |Rent | $ 10,800 | | |

| |Supplies | $ 5,774 | | |

| |Utilities | $ 4,695 | | |

| |Salaries | $ 4,734 | | |

| |Cost of Goods Sold | $ 64,729 | | |

| |Interest | $ 2,938 | | |

| |Insurance | $ 825 | | |

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|B. Statement of Retained Earnings Preparation |

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|Purpose of the Statement: |

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|Use the form below to prepare statement of retained earnings for Shutterbug Cameras for the year ended June 30. Shutterbug started the year with retained |

|earnings of $14,364. The company declared a dividend for all shareholders of $15,000. Preferred shareholders were entitled to $5,000 of the dividend. |

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|C. Balance Sheet Preparation |

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|Purpose of Statement: |

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|Use the form below to prepare a balance sheet for Shutterbug Cameras for the June 30. Shutterbug provided the following information: |

| |Accounts Payable | $ 14,481 | | |

| |Accounts Receivable | $ 5,418 | | |

| |Cash in Bank | $ 137,721.20 | | |

| |Common Stock | $ 60,000 | | |

| |Inventory | $ 82,763 | | |

| |Land and Building | $ 6,303 | | |

| |Lease | $ 64,410 | | |

| |Paid-In Capital in Excess of Par | $ 75,000 | | |

| |Preferred Stock | $ 25,000 | | |

| |Sales Tax Payable | $ 891 | | |

| |Store Equipment | $ 26,769 | | |

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|D. Cash Flow Statement Preparation |

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|Purpose of Statement: |

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|Use the form below to prepare a cash flow statement for Shutterbug Cameras for the year ended June 30. Shutterbug had the following additional payments and |

|receipts: |

| |Bonds Issued/Paid | $ ( 9,106 ) | | |

| |Common Stock Issued/Repurchased | $ 10,000 | | |

| |Payments from Accounts Receivable | $ 8,751 | | |

| |Payments of Accounts Payable | $ (17,139) | | |

| |Purchase/Sale of Assets | $ ( 1,067) | | |

| |Purchase/Sale of Marketable Securities | $ 4,231 | | |

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Section 3.2 Homework

1) How is profit or loss calculated on an income statement?

1) What important financial information is not reflected in either the balance sheet or the income statement?

2) Which financial statement proved the accounting equation?

3) Which financial statement gives the best indication of a company’s ability to compete in the future?

4) Which number of the financial statements represents the amount of income available to stockholders?

5) What items can cause a change in retained earnings?

6) Textbook page 79 – Questions 1, 2, 3, 4, 5, 8

7) Identify the statement(s) on which each account is found:

A. Vehicles

A. Taxes

B. Selling Expense

C. Sales Revenue

D. Retained Earnings

E. Preferred Stock

F. Operating Expense

G. Notes Payable

H. Marketable Securities

I. Machinery

J. Long-Term Debts

K. Land

L. Inventories

M. Interest Expense

N. General Expense

O. Equipment

B. Dividends

P. Common Stock

Q. Cash

R. Buildings

S. Administrative Expense

T. Accounts Receivable

U. Accounts Payable

34) Use the information to prepare an income statement, statement of retained earnings, balance sheet and cash flow statement for Kramer Corporation for the year ended December 31. All numbers are in thousands.

Accounts Payable $80.0

Accounts Receivable $200.0

Accumulated Depreciation $600.0

Cash $40.0

Common Stock Dividends $39.5

Common Stock $100.0

Cost of Goods Sold $1,500.0

Depreciation Expense $50.0

Fixed Liabilities $90.0

Interest Expense $20.0

Inventory $190.5

Marketable Securities $10.0

Notes Payable $100.0

Other Assets $70.0

Other Current Liabilities $30.0

Paid-In Capital in excess of par $250.0

Plant & Equipment $1,100.0

Preferred Stock Dividends $10.5

Preferred Stock, $100 par, 500 shares $50.0

Retained Earnings, Jan. 1 $250.0

Sales $2,000.0

Selling and Admin. Expense $220.0

Taxes $99.5

Additional Information for Cash Flow Statement

Payment from Accounts Receivable $10.5

Payments of Accounts Payable ($50.0)

Sale of Assets $9.5

Purchase of Marketable Securities ($200.0)

Common Stock Issued $15.0

Bonds Paid ($1,000.0)

35) Use the information given to prepare an income statement, statement of retained earnings, balance sheet and cash flow statement for Argyle Textiles for the year ended December 31. All numbers are in millions.

Tax Expense $18.0

Sales $750.0

Salary Expense $15.0

Retained Earnings $130.0

Rent Expense $40.0

Preferred Stock $5.0

Preferred Dividends $4.0

Notes Payable $50.0

Marketable Securities $1.2

Long-Term Bonds $152.2

Land and Buildings $345.0

Inventory $135.0

Interest Expense $20.0

Depreciation Expense $30.0

Cost of Goods Sold $600.0

Common Stock $10.0

Common Dividends $10.0

Cash in Bank $9.0

Accumulated Depreciation $155.0

Accounts Payable $15.0

Accounts Receivable $90.0

Paid-In Capital in Excess of Par $50.0

Additional Information for Cash Flow Statement

Payment from Accounts Receivable $5.5

Payments of Accounts Payable ($5.0)

Sale of Assets $9.5

Sale of Marketable Securities $2.0

Common Stock Repurchased ($1.0)

Bonds Issued $1.0

36) Use the information given to prepare an income statement, statement of retained earnings, balance sheet and cash flow statement for Computron Industries for the year ended December 31.

Cash $52,000

Accounts Receivable $402,000

Inventories $836,000

Plant and Equipment $527,000

Accumulated Depreciation $166,200

Accounts Payable $315,200

Notes Payable $225,000

Bonds Payable $424,612

Common Stock $100,000

Paid-in Capital in Excess of Par $300,000

Preferred Stock $60,000

Retained Earnings $279,768

Sales $3,850,000

Cost of Goods Sold $3,250,000

Administrative Expenses $430,300

Selling Expenses $20,000

Interest Expense $76,000

Tax $29,480

Common Stock Dividends $86,000

Preferred Stock Dividends $12,000

Additional Information for Cash Flow Statement

Bonds Issued $10,000

Payment from Accounts Receivable $114,000

Payments of Accounts Payable ($95,000)

Purchase of Marketable Securities ($20,000)

Sale of Assets $9,500

37) Textbook page 96 & 97 – Question 20, 23, 26-28.

38) Which accounts should you add together to get total common stockholders’ equity?

Income Statement

Sales

- Cost of Goods Sold

Gross Profit

- Operating Expenses

Operating Profit

- Interest Expense

Income before taxes

- Tax Expense

Net Income

Balance Sheet

Assets

Current Assets

+ Fixed Assets

Total Assets

Liabilities

Current Liabilities

+ Long-Term Liabilities

Total Liabilities

Stockholders’ Equity

+ Preferred Stock

+ Common Stock

+ Paid-In Capital in Excess of Par

+ Retained Earnings

Total Stockholders’ Equity

Total Liabilities and S/E

Cash Flow Statement

Cash Flow from Operations

Net Income

+ Payments from A/R

- Payments to A/P

Cash Flow from Operations

Cash Flow from Investing

Purchase/Sale of Assets

+/- Purchase Sale of Marketable Sec.

Cash Flow from Investing

Cash Flow from Financing

Common Stock Issue/Repurchase

- Stock Dividends

+/- Bonds Issued/Paid

Cash Flow from Financing

Net Cash Flow

Statement of Retained Earnings

Beginning Retained Earnings

+ Net Income

- Dividend Payments

Ending Retained Earnings

Financial Analysis

Part Three – Ratio Analysis

Section 4.4

Goals

• Recognize important ratios used to analyze the financial condition of a business

• Identify the five ratio categories and the purpose of each category

• Use current financial statements to perform a complete ratio analysis for a company

• Analyze ratios using cross-sectional and time-series analysis

• Define leverage and explain how it can be used to improve investor return

Vocabulary

financial ratios

ratio analysis

financial leverage

benchmark company

cross-sectional analysis

time-series analysis

liquidity ratios

activity ratios

debt ratios

profitability ratios

market ratios

profit margin

EBIT

ROA

ROE

EPS

P/E Ratio

Hoover’s

RATIO ANALYSIS

|Ratio |Formula |What It Means |

|Liquidity - ability to satisfy short-term debt |

|Current Ratio |Current Assets |Value of liquid assets available to cover short-term debt |

| |Current Liabilities | |

|Quick Ratio |Current Assets – Inventory |Same as current except inventory is not included in liquid assets |

| |Current Liabilities | |

|Activity – speed with which various accounts are converted into sales or cash |

|Inventory Turnover |Sales |How many times during the year the company turns over inventory (reorders) |

| |Inventory | |

|Average Age of Inventory |360 |How many days goods stay in stock before being sold |

| |Inventory Turnover | |

|Accounts Receivable Turnover |Total Sales |How quickly customer accounts are paid |

| |A/R | |

|Average Collection Period |Accounts Receivable |Number of days it takes company to collect from customers |

| |Sales ÷ 360 | |

|Total Asset Turnover |Sales |How efficiently the company is using its assets to generate sales |

| |Total Assets | |

|Debt Ratios – degree of indebtedness and the ability of the firm to pay debts |

|Debt Ratio |Total Liabilities |Percentage of firms assets owned by others (creditors). |

| |Total Assets | |

|Times Interest Earned |Operating Income |How many times a year the company makes enough income to pay interest expenses |

| |Interest Expense | |

|Profitability – ability to earn income |

|Gross Profit Margin |Gross Profit |Percentage of sales dollar left after goods are purchased |

| |Sales | |

|Operating Profit Margin |Operating Profit |Percentage of sales dollar left after goods are purchased & operating expenses |

| |Sales |paid |

|Net Profit Margin |Net Income |Percentage of sales dollar left after all expenses are deducted |

| |Sales | |

|Return on Assets |Net Income |How much money the firm earned from each dollar of asset investment |

| |Total Assets | |

|Return on Equity |Net Income |How much money the firm earned from each dollar of shareholder investment |

| |CS Equity | |

|Market Ratios – relate a firm’s current price in the market to the accounting values |

|Earnings per Share |Net Income |Number of dollars earned on behalf of each shareholder. |

| |# CS shares outstanding | |

|Price/Earnings (P/E) |Market Price |How much money are investors willing to pay for each dollar of a firm’s earnings |

| |Earnings per Share | |

|Market to Book |Market Price |How much more investors are willing to pay for stock than the amount listed in |

| |CS Equity ÷ Issued Shares |the balance sheet |

Section 4.4 Homework

1) What is the purpose of performing a ratio analysis?

1) What three activities are required when performing a ratio analysis?

2) What are the five categories of financial ratios? What does each category tell you about the business?

3) Under what circumstances would the current ratio be the preferred measure of overall firm liquidity? Under what circumstances would the quick ratio be preferred?

4) A company has a total asset turnover of 0.85. What does this number mean? Who would be most interested in this number: the stockholders or the managers? Why?

5) What ratio measured the degree of indebtedness? What ratio assesses the firm’s ability to pay debts?

6) Why is it important to calculate all three profit margins (gross, operating and net)?

7) What would explain a firm’s having a high gross profit margin and a low net profit margin?

8) Which measure of profitability is probably of greatest interest to the investing public? Why?

9) Why are market-to-book ratios generally greater than 1.0?

10) What should you consider when selecting which comparative information to use?

11) What is a benchmark company and how is it used when analyzing financial ratios?

12) Textbook page 133 – Questions 1, 2, 3, 4, 5

13) Textbook page 136 – Questions 19, 22

14) Beacon Company’s total current assets, total current liabilities, and inventory for the past 4 years follow:

|Item | 1998 | 1999 | 2000 | 2001 |

|Total current assets |$ 16,950 |$ 21,900 |$ 22,500 |$ 27,000 |

|Total current liabilities | 9,000 | 12,600 | 12,600 | 17,400 |

|Inventory | 6,000 | 6,900 | 6,900 | 7,200 |

a. Calculate the firm’s current and quick ratios for each year.

b. Comment on the firm’s liquidity over the 1998-2001 period.

c. If you were told that Beacon Company’s inventory turnover for 1998-2001 and the industry averages were as follows, would this support or conflict with your evaluation in part b? Why?

|Inventory turnover |1998 |1999 |2000 |2001 |

|Industry average |10.6 |11.2 |10.8 |11.0 |

1) The new owners of Celestial Natural Foods have hired you to help them diagnose and cure problems that the company has had in maintaining adequate liquidity. First, you perform a liquidity analysis. You then do an analysis of the company’s short-term activity ratios. Your calculations and industry norms are listed.

| |Celestial |Industry norm |

|Current ratio |4.5 |4.0 |

|Quick ratio |2.0 |3.1 |

|Inventory turnover |6.0 |10.4 |

|Average collection period |73 days |52 days |

a. What recommendations about the amount and the handling of inventory could you make to the new owners?

b. What recommendations about amount and handling of accounts receivable could you make to the owners?

2) Gemtel, Inc., ended 2001 with net profit before taxes of $218,000. The company is subject to a 40% tax rate and must pay $32,000 in preferred stock dividends before distributing any earnings on the 85,000 shares of common stock currently outstanding.

a. Calculate Gemtel’s 2001 earnings per share (EPS).

b. If the firm paid common stock dividends of $0.80 per share, how many dollars would go to retained earnings?

3) Complete the 2001 balance sheet for Orphan Industries using the information that follows it.

Balance Sheet

Orphan Industries

December 31, 2001

Cash $ 30,000 Accounts payable $ 120,000

Marketable securities 25,000 Notes payable ________

Accounts receivable ________ Accruals 20,000

Inventories 225,000 Total current liabilities ________

Total current assets ________ Long-term debt ________

Net fixed assets ________ Stockholders’ equity 600,000

Total assets ________ Total liabilities & stockholders’ equity ________

The following financial data for 2001 is also available:

(1) Sales totaled $1,800,000.

(2) There are 360 days in the year.

(3) The average collection period was 40 days.

(4) The current ratio was 1.60.

(5) The total asset turnover ratio was 1.20.

(6) The debt ratio was 60%.

4) Arnold Roberts recently inherited a stock portfolio from his uncle who was a very wise investor. To learn more about the companies that he is now invested in, Arnold performs a ratio analysis on each one and decides to compare them to each other. Some of his ratios are listed below.

| |Atlantic |Mighty |Think Software |Rauch |

| |Electric Utility |Burger | |Motors |

|Current ratio |1.10 |1.3 |6.8 |4.5 |

|Quick ratio |0.90 |0.82 |5.2 |3.7 |

|Debt ratio |0.68 |0.46 |0 |0.35 |

|Net profit margin |6.2% |14.3% |28.5% |8.4% |

Arnold finds the wide differences in these ratios confusing. Help him out.

a. What problems might Arnold encounter in comparing the ratios of these companies to one another?

b. Why might the current and quick ratios for the electric utility and the fast-food stock be so much lower than the same ratios for the other companies?

c. Why might it be all right for the electric utility to carry a large amount of debt, but the same is not true for the software company?

d. Why wouldn’t investors invest all of their money in software companies instead of less profitable companies?

5) Winner Paper and Oregon Forest are rivals in the manufacture of craft papers. Some financial statement values for each company are listed below.

| | Winner Paper | Oregon Forest |

|Total assets | $ 10,000,000 | $ 10,000,000 |

|Total common equity |9,000,000 |5,000,000 |

|Total debt |1,000,000 |5,000,000 |

|Annual interest |100,000 |500,000 |

|Total sales |$ 25,000,000 |$ 25,000,000 |

|EBIT |6,250,000 |6,250,000 |

|Net income |3,690,000 |3,450,000 |

a. Calculate the (1) debt ratio and (2) times interest earned ratio for the two companies. Discuss their financial risk and ability to cover the costs in relation to each other.

b. Calculate the (1) operating profit margin, (2) net profit margin, (3) return on total assets, and (4) return on common equity for the two companies. Discuss their profitability relative to each other.

c. In what way has the larger debt of Oregon Forest made it more profitable than Winner Paper? What are the risks that Oregon’s investors undertake when they choose to purchase its stock instead of Winner’s?

6) Rock Enterprises has requested a $4,000,000 loan. Zenia Bank is evaluating Rock to assess its financial position. On the basis of the debt ratios for Rock, along with the industry averages and Rock’s recent financial statements, evaluate and recommend appropriate action on the loan request.

|Income Statement |

|Rock Enterprises |

|for the year ended December 31, 2001 |

|Sales revenue | |$30,000,000 |

|Less: Cost of goods sold | |21,000,000 |

|Gross profits | |$ 9,000,000 |

|Less: Operating expenses | |6,000,000 |

|Operating profits | |$ 3,000,000 |

|Less: Interest expense | |1,000,000 |

|Net profits before taxes | |$ 2,000,000 |

|Less: Taxes (rate = 40%) | |800,000 |

|Net profits after taxes | |$ 1,200,000 |

|Less: Preferred stock dividends | |100,000 |

|Earnings available for common stockholders | |$ 1,100,000 |

|Balance Sheet |

|Rock Enterprises |

|December 31, 2001 |

|Assets | |Liabilities & Stockholders’ Equity | |

|Current assets | |Current liabilities | |

|Cash |$ 1,000,000 |Accounts payable |$ 8,000,000 |

|Marketable securities |3,000,000 |Notes payable |8,000,000 |

|Accounts receivable |12,000,000 |Accruals |500,000 |

|Inventories |7,500,000 |Total current liabilities |$16,500,000 |

|Total current assets |$23,500,000 |Long-term debtb |$20,000,000 |

|Gross fixed assets (at cost)a | |Stockholders’ equity | |

|Land and buildings |$11,000,000 |Preferred stock ($4 dividend) |$ 2,500,000 |

|machinery and equipment |20,500,000 |Common stock |5,000,000 |

|Furniture and fixtures |8,000,000 |Paid-in capital in excess of par |4,000,000 |

|Gross fixed assets |$39,500,000 |Retained earnings |2,000,000 |

|Less: Accum. depreciation |13,000,000 |Total stockholders’ equity |$13,500,000 |

|Net fixed assets |$26,500,000 |Total liabilities & stock. equity |$50,000,000 |

|Total assets |$50,000,000 | | |

|a The firm has a lease requiring annual payments of $200,000. Three years of the lease have yet to run. |

|bRequired annual principal payments are $800,000. |

|Industry Averages |

|Debt ratio |0.51 |

|Times interest earned ratio |7.30 |

7) Solana Printing, Inc., had sales totaling $40,000,000 in fiscal year 2001. Some ratios for the company are listed below. Use this information to calculate the dollar values of the following accounts:

|Solana Printing, Inc. |

|Gross profit margin | 80% |

|Operating profit margin |35% |

|Net profit margin |8% |

|Return on total assets |16% |

|Return on common equity |20% |

|Total asset turnover |2 |

|Average collection period |62.2 days |

A. Gross profits

B. Cost of goods sold

C. Operating profits

D. Operating expense

E. Net Income

F. Total assets

G. Total common stock equity

H. Accounts receivable

8) Use the financial statements for Mark Manufacturing Company along with the industry average to (a.) prepare a complete ratio analysis of the firm’s 2001 operations. (b.) Summarize your findings.

|Mark Manufacturing Company |

|Income Statement |

|Year Ended December 31, 2001 |

|Sales Revenue |$600,000 |

|Cost of Goods Sold |460,000 |

|Gross Profit |$140,000 |

|Operating Expenses |60,000 |

|Operating Profits |$80,000 |

|Interest Expense |10,000 |

|Net Income before taxes |$70,000 |

|Tax Expense |27,100 |

|Net Income |$42,900 |

|Earnings per Share (EPS) |$2.15 |

|Mark Manufacturing Company |

|Balance Sheet |

|December 31, 2001 |

|Assets | | |Liabilities and Stockholders’ Equity |

|Cash |$15,000 | |Accounts Payable |$57,000 |

|Marketable Securities |7,200 | |Notes Payable |13,000 |

|Accounts Receivable |34,100 | |Accruals |5,000 |

|Inventories |82,000 | | Total Current Liabilities |$75,000 |

| Total Current Assets |$138,300 | |Long-term Debt |$150,000 |

|Net Fixed Assets |270,000 | |Stockholders’ Equity | |

|Total Assets |$408,300 | | Common Stock (20,000 shares issued) |$110,200 |

| | | | Retained Earnings |73,100 |

| | | | Total Stockholders’ Equity |$183,300 |

| | | |Total Liabilities & Stockholders’ Equity |$408,300 |

|Industry Averages |

|Current ratio |2.35 | |Times interest earned ratio |12.3 |

|Quick ratio |0.87 | |Gross profit margin |0.202 |

|Inventory turnover |4.55 | |Operating profit margin |0.135 |

|Average collection period |35.3 days | |Net profit margin |0.091 |

|Total asset turnover |1.09 | |Return on total assets (ROA) |0.099 |

|Debt ratio |0.30 | |Return on common equity (ROE) |0.167 |

| | | |Earnings per Share (EPS) |$3.10 |

9) Use the financial statements for Jessica Industries to complete the chart. Then analyze Jessica Industries’ financial condition as it relates to (1) liquidity, (2) activity, (3) debt, (4) profitability, and (5) market. Summarize the company’s overall financial condition.

|Ratio |Industry average |Actual 2000 |Actual 2001 |

|Current ratio | 1.80 | 1.84 | ______ |

|Quick ratio |0.70 |0.78 |______ |

|Average collection period |37 days |36 days |______ |

|Debt ratio |65% |67% |______ |

|Times interest earned ratio |3.8 |4.0 |______ |

|Gross profit margin |38% |40% |______ |

|Net profit margin |3.5% |3.6% |______ |

|Return on total assets |4.0% |4.0% |______ |

|Return on common equity |9.5% |8.0% |______ |

|Market/book ratio |1.1 |1.2 |______ |

|Jessica Industries |

|Income Statement for year ended December 31, 2001 |

|Sales revenue |$ 160,000 |

|Less: Cost of goods sold |106,000 |

|Gross profits |$ 54,000 |

|Less: Operating expenses |$ 37,000 |

|Operating profits |$ 17,000 |

|Less: Interest expense |6,100 |

|Net profits before taxes |$ 10,900 |

|Less: T axes |4,360 |

|Net profits after taxes |$ 6,540 |

|Jessica Industries |

|Balance Sheet for December 31, 2001 |

|Assets | | |Liabilities and Stockholders’ Equity |

|Cash |$500 | |Accounts Payable |$22,000 |

|Marketable Securities |1,000 | |Notes Payable |47,000 |

|Accounts Receivable |25,000 | | Total Current Liabilities |$69,000 |

|Inventories |45,000 | |Long-term Debt |$22,950 |

| Total Current Assets |$72,000 | | Common Stock (3,000 shares issued)* |$31,500 |

|Net Fixed Assets |78,000 | | Retained Earnings |26,550 |

|Total Assets |$150,000 | |Total Liabilities & Stockholders’ Equity |$150,000 |

The firm’s stock closed 2001 at a price of $25 per share.

Integrative Problems

10) Charter Air, Inc., reported net income of $1,365,000 for the year ended December 31, 2001. Show the effect of these funds on the firm’s balance sheet in each of the scenarios following the balance sheet.

Charter Air, Inc.

Balance Sheet

December 31, 2000

Cash $ 120,000 Accounts payable $ 70,000

Marketable securities 35,000 Short-term notes 55,000

Accounts receivable 45,000 Current liabilities $ 125,000

Inventories 130,000 Long-term debt $2,700,000

Current assets $ 330,000 Total liabilities $2,825,000

Equipment $2,970,000 Common Stock $ 500,000

Buildings 1,600,000 Retained earnings 1,575,000

Fixed assets $4,570,000 Stockholders’ equity $2,075,000

Total assets $4,900,000 Total liabilities and equity $4,900,000

a. Charter paid no dividends during the year and invested the funds in marketable securities.

b. Charter paid dividends totaling $500,000 and used the balance of net income to retire long-term debt.

c. Charter paid dividends totaling $500,000 and invested the balance of net income in building a new hangar.

d. Charter paid out all $1,365,000 as dividends to its stockholders.

11) Kleck Corporation has one issue of preferred stock and one issue of common stock outstanding. Given Kleck’s stockholders’ equity account that follows, determine the original price per share at which the firm sold its single issue of common stock.

|Preferred stock |$125,000 |

|Common stock ($0.75 par, 300,000 shares outstanding) |225,000 |

|Paid in capital in excess of par on common stock |2,625,000 |

|Retained earnings |900,000 |

|Total Stockholders’ equity |$3,875,000 |

12) Listed are the equity sections of balance sheets for years 2000 and 2001 as reported by Resort World, Inc. The overall value of stockholders’ equity has risen from $2,000,000 to $7,500,000. Use the statements to discover how and why this happened.

Resort World Inc.

2000 2001

Stockholders’ equity

Common stock ($1.00 par)

Authorized – 5,000,000 shares

Outstanding – 1,500,000 shares 2001

- 500,000 shares 2000 $ 500,000 $1,500,000

Paid-in capital in excess of par 500,000 4,500,000

Retained earnings 1,000,000 1,500,000

Total stockholders’ equity $2,000,000 $7,500,000

The company paid total dividends of $200,000 during fiscal 2001.

a. What was Resort World’s net income for fiscal 2001?

b. How many new shares did the corporation issue and sell during the year?

c. At what average price per share did the stock sold during 2001 sell?

d. At what price per share did Resort World’s original 500,000 shares sell?

Financial Analysis

Part Four – Time Value of Money

Section 3.4

Goals

■ Discuss the role of time value in finance

■ Know how to calculate time value problems using a financial calculator

■ Understand the concepts of future value and present value

■ Calculate future and present values for a single amount

■ Calculate the effective annual rate

■ Understand the concept of an annuity and perpetuity

■ Calculate future and present values for annuities

Vocabulary

Time value of money

Simple interest

Compound interest

Future value

Compounding

Present value

Discounting

Effective Annual Rate

Annuity

Annuity due

Perpetuity

Rule of 72

Section 3.4 Interest Rates and Time Value of Money

Role of Time Value in Finance

1 Most financial decisions involve ____________ and _______________ that are spread out over ___________.

2 Time value of money allows _________________ of cash flows from ______________________ periods.

Types of Interest

1 Simple Interest -

2 Compound Interest -

Sample Problems – Lump Sums

|Case |Lump Sum |Interest Rate |Years |Future Value |Present Value |

|A |$200 |5% |20 | | |

|B |4,500 |8 |7 | | |

|C |10,000 |9 |10 | | |

|D |25,000 |10 |12 | | |

|E |37,000 |11 |5 | | |

|F |40,000 |12 |9 | | |

More on Compound Interest

1 Compounding more frequently than once a year will result in a ______________ effective interest rate because you are earning interest on interest more frequently.

2 As a result, the ___________________ interest rate is greater than the ____________________ interest rate.

3 The effective rate of interest _________________ the more frequently interest is compounded.

Sample Problems - Compounding

Case |Lump Sum |Interest Rate |Years |Compounding Frequency |Future Value |Present Value |EAR | |A |$2,500 |6% |20 |2 | | | | |B |50,000 |12 |7 |6 | | | | |C |1,000 |5 |10 |1 | | | | |D |20,000 |16 |12 |4 | | | | |

Annuities - ____________________ - spaced cash flows of ___________________ size

1 Can be a cash ______________________ or cash ________________________

2 Types

1 Ordinary – payments received/due at the _________________ of the period.

2 Due – payments received/due at the _____________________________ of the period.

3 Perpetuity – annuity with a cash flow that continues _________________________.

Sample Problems - Annuities

Case |Type |Payment |Interest Rate |Years |Future Value |Present Value | |A |Ordinary |$12,000 |7% |3 | | | |B |Ordinary |55,000 |12 |15 | | | |C |Ordinary |700 |20 |9 | | | |D |Ordinary |140,000 |5 |7 | | | |E |Due |22,500 |10 |5 | | | |F |Ordinary |100,000 |10 |( |N/A | | |G |Due |3,000 |8 |4 | | | |

Section 3.4 Homework

Lump Sum Problems

1. What is the difference between simple interest and compound interest?

2. What is the difference between future value and present value?

3. What effect would a decrease in the interest rate have on the future value of a deposit? What effect would an increase in the holding period have on future value?

4. Larry Doby invests $50,000 in a mint condition 1952 Mickey Mantle Topps baseball card. He expects the card to increase in value 8% per year for the next five years. How much will his card be worth after five years?

5. At a growth rate of 9 percent annually, how long will it take for a sum to double? To triple? Round the answer to the nearest whole number of years. Bonus: How does the Rule of 72 apply to this question?

6. You have $1,500 to invest today at 7% interest.

a. Find how much you will have accumulated in the account at the end of (1) three years; (2) six years;

(3) nine years.

b. Use your findings in part a to calculate the amount of interest earned in (1) the first three years (years 1 to 3); (2) the second three years (years 4 to 6); and (3) the third three years (years 7 to 9).

c. Explain why the amount of interest earned increases in each succeeding 3-year period.

7. As part of your financial planning, you wish to purchase a new car exactly 5 years from today. The car you wish to purchase costs $14,000 today, and your research indicates that its price will increase by 2% to 4% per year over the next five years.

a. Estimate the price of the car at the end of 5 years if inflation is (1) 2% per year; (2) 4% per year.

b. How much more expensive will the car be if the rate of inflation is 4% rather than 2%?

8. You can deposit $10,000 into an account paying 9% interest either today or exactly 10 years from today. How much better off will you be at the end of 40 years if you decide to make the initial deposit today rather than ten years from today?

9. What effect does increasing the required return have on the present value of a future amount? Why?

10. How are present value and future value calculations related?

11. You owe a creditor $40,000 in seven years. If you decide to payoff the loan today, what is the most you should pay the creditor to payoff the loan in full if the prevailing interest rate is 9%?

12. You need $28,974 at the end of 10 years. Your only investment option is an 8% long-term CD compounded annually. What single payment could be made at the beginning of the first year to achieve this objective?

Compounding Problems

13. What effect does compounding interest more frequently than annually have on future value?

14. What effect does compounding interest more frequently than annually have on effective annual rate?

15. Juan Garza invested $20,000 ten years ago at 12% interest compounded quarterly. How much has he accumulated in the investment?

16. The First City Bank pays 7% interest compounded annually on deposits. The Second City Bank pays 6.5% interest compounded quarterly. Based on their effective interest rates, in which bank would you prefer to deposit your money?

Annuity Problems

17. You have decided to heed the sage advice of your finance teacher and put aside $2,000 a year beginning with your 25th birthday and continuing for 10 years. Your best friend, on the other hand, decides to wait until s/he is 35 before making the $2,000 annual payments. Provide the information requested about the investments assuming a 10% compounding rate.

a. How much money will you deposit over the 10-year period?

b. How much money will your best friend deposit over the 30-year period?

c. How much money will you have at your age 65?

d. How much money will your best friend have at age 65?

18. You have won the lottery and are trying to decide whether to take the lump sum payment or the annuity. The annuity has a value of $9 million dollars to be paid in annual payments over the next 20 years. If the annuity earns 5% interest, what will be the amount of the lump sum payment? What factors should you consider when deciding between the annuity and lump sum payment?

19. Your favorite aunt has left you some money in her will. The will specifies that you will receive: $1,000 one year from her death; $2,000 two years from her death; and $3,000 three years from her death. How much is your aunt’s gift worth today? Use 8% interest.

20. You would like to give back to the Council Rock community by funding an endowment for the Parks & Recreation Department. You would like the department to have $15,000 available every year for community programs. How much money would you need to invest today to fund this endowment at 7% interest?

21. Sue wants to buy a car that costs $12,000. She has arranged to borrow the total purchase price of the car from her credit union at a simple interest rate equal to 12 percent. The loan requires quarterly payments for a period of three years. If the first payment is due in three months (one quarter) after purchasing the car, what will be the amount of Sue’s quarterly payments on the loan?

Reinforcement Problems

22. You are planning to retire in twenty years. You'll live ten years after retirement. You want to be able to draw out of your savings at the rate of $10,000 per year. How much would you have to pay in equal annual deposits until retirement to meet your objectives? Assume interest remains at 9%.

23. You can deposit $4000 per year into an account that pays 12% interest. If you deposit such amounts for 15 years and start drawing money out of the account in equal annual installments, how much could you draw out each year for 20 years?

24. What is the value of a $100 perpetuity if interest is 7%?

25. You deposit $13,000 at the beginning of every year for 10 years. If interest is being paid at 8%, how much will you have in 10 years?

26. You are getting payments of $8000 at the beginning of every year and they are to last another five years. At 6%, what is the value of this annuity?

27. How much would you have to deposit today to have $10,000 in five years at 6% interest compounded semiannually?

28. If you get payments of $15,000 per year for the next ten years and interest is 4%, how much would that stream of income be worth in present value terms?

29. Your company must make equal annual beginning of year payments to have enough money to retire an $800,000 bond that matures in 15 years. Assuming you can earn 4% interest, how much must the payments be?

30. If you deposit $45,000 into an account earning 4% interest compounded quarterly, how much would you have in 5 years?

31. How much would you pay for an investment that will be worth $16,000 in three years? Assume interest is 5%.

32. You have $100,000 to invest at 4% interest. If you wish to withdraw equal annual payments for 4 years, how much could you withdraw each year and leave $0 in the investment account?

33. You are considering the purchase of two different insurance annuities. Annuity A will pay you $16,000 at the beginning of each year for 8 years. Annuity B will pay you $12,000 at the end of each year for 12 years. Assuming your money is worth 7%, and each costs you $75,000 today, which would you prefer?

34. If your company borrows $300,000 at 8% interest and agrees to repay the loan in 10 equal semiannual payments to include principal plus interest, how much would those payments be?

35. You deposit $17,000 each year for 10 years at 7%. Then you earn 9% after that. If you leave the money invested for another 5 years how much will you have in the 15th year?

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0. Collect and analyze source documents

Computational Aid 1

$4,000

5,000

$3,000

$2,000

$3,000

-$10,000

To Access the Finance Functions:

❑ APPS…FINANCE…TVM

To Solve a Problem:

❑ The cursor should be on the item for which you are solving

❑ Press ALPHA…SOLVE

N:

I%:

PV:

PMT:

FV:

P/Y:

C/Y:

PMT:

0

End of Year

1

2

3

4

5

Effective Annual Rate (EAR)

EAR = (1 + i/m)m - 1

where m equals the number of compounds per year

Perpetuity

PV = Annuity / i

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