1、Chapter 2Discussion Questions2-1.Discuss some financial variables that affect the price-earnings ratio.The price-earnings ratio will be influenced by the earnings and sales growth of the firm, the risk or volatility in performance, the debt-equity structure of the firm, the dividend payment policy,

2、the quality of management, and a number of other factors. The ratio tends to be future-oriented, and the more positive the outlook, the higher it will be.2-2.What is the difference between book value per share of common stock and market value per share? Why does this disparity occur?Book value per s

3、hare is arrived at by taking the cost of the assets and subtracting out liabilities and preferred stock and dividing by the number of common shares outstanding. It is based on the historical cost of the assets. Market value per share is based on current assessed value of the firm in the marketplace

4、and may bear little relationship to original cost. Besides the disparity between book and market value caused by the historical cost approach, other contributing factors are the growth prospects for the firm, the quality of management, and the industry outlook. To the extent these are quite negative

5、 or positive, market value may differ widely from book value.2-3.Explain how depreciation generates actual cash flows for the company.The only way depreciation generates cash flows for the company is by serving as a tax shield against reported income. This non-cash deduction may provide cash flow eq

6、ual to the tax rate times the depreciation charged. This much in taxes will be saved, while no cash payments occur.2-4.What is the difference between accumulated depreciation and depreciation expense? How are they related?Accumulated depreciation is the sum of all past and present depreciation charg

7、es, while depreciation expense is the current years charge. They are related in that the sum of all prior depreciation expense should be equal to accumulated depreciation (subject to some differential related to asset write-offs).2-5.How is the income statement related to the balance sheet?The earni

8、ngs (less dividends) reported in the income statement is transferred to the ownership section of the balance sheet as retained earnings. Thus, what we earn in the income statement becomes part of the ownership interest in the balance sheet.2-6.Comment on why inflation may restrict the usefulness of

9、the balance sheet as normally presented.The balance sheet is based on historical costs. When prices are rising rapidly, historical cost data may lose much of their meaningparticularly for plant and equipment and inventory.2-7.Explain why the statement of cash flows provides useful information that g

10、oes beyond income statement and balance sheet data.The income statement and balance sheet are based on the accrual method of accounting, which attempts to match revenues and expenses in the period in which they occur. However, accrual accounting does not attempt to properly assess the cash flow posi

11、tion of the firm. The statement of cash flows fulfills this need.2-8.What are the three primary sections of the statement of cash flows? In what section would the payment of a cash dividend be shown?The sections of the statement of cash flows are:Cash flows from operating activitiesCash flows from i

12、nvesting activitiesCash flows from financing activitiesThe payment of cash dividends falls into the financing activities category.2-9.What is free cash flow? Why is it important to leveraged buyouts?Free cash flow is equal to cash flow from operating activities:Minus:Capital expenditures required to

13、 maintain the productive capacity of the firm.Minus:Dividends (required to maintain the payout on common stock and to cover any preferred stock obligation).The analyst or banker normally looks at free cash flow to determine whether there are insufficient excess funds to pay back the loan associated

14、with the leveraged buy-out.2-10.Why is interest expense said to cost the firm substantially less than the actual expense, while dividends cost it 100 percent of the outlay?Interest expense is a tax deductible item to the corporation, while dividend payments are not. The net cost to the corporation o

15、f interest expense is the amount paid multiplied by the difference of one minus the applicable tax rate.For example, $100 of interest expense costs the company $65 after taxes when the corporate tax rate is 35 percent. (e.g. $100 x (1 .35) = $65).Problems2-1.Rockwell Paper Company had earnings after

16、 taxes of $580,000 in the year 2003 with 400,000 shares outstanding. On January 1, 2004, the firm issued 35,000 new shares. Because of the proceeds from these new shares and other operating improvements, earnings after taxes increased by 25 percent.a.Compute earnings per share for the year 2003.b.Co

17、mpute earnings per share for the year 2004.Solution:Rockwell Paper Companya.Year 2003b.Year 20042-2.Given the following information, prepare, in good form, an income statement for the Goodman Software, Inc.Selling and administrative expense$ 50,000Depreciation expense80,000Sales400,000Interest expen

18、se30,000Cost of goods sold150,000Taxes18,550Solution:Goodman Software, Inc.Sales$400,000Cost of goods sold150,000Gross Profit250,000Selling and administrative expense50,000Depreciation expense80,000Operating profit120,000Interest expense30,000Earnings before taxes90,000Taxes18,550Earnings after taxe

19、s$71,4502-3.a.Kevin Bacon and Pork Company had sales of $240,000 and cost of goods sold of $108,000. What is the gross profit margin (ratio of gross profit to sales)?b.If the average firm in the pork industry had a gross profit of 60 percent, how is the firm doing?Solution:Kevin Bacon and Port Compa

20、nya.Sales$240,000Cost of goods sold 180,000Gross profit$132,000b.With a gross profit 55 percent, the firm is under-performing the industry average of 60 percent.2-4.Prepare in good form an income statement for Virginia Slim Wear. Take your calculations all the way to computing earnings per share.Sal

21、es$600,000Shares outstanding100,000Cost of goods sold200,000Interest expense30,000Selling and administrative expense40,000Depreciation expense20,000Preferred stock dividends80,000Taxes100,000Solution:Virginia Slim WearIncome StatementSales$600,000Cost of goods sold200,000Gross profit400,000Selling a

22、nd administrative expense40,000Depreciation expense20,000Operating profit340,000Interest expense30,000Earnings before taxes310,000Taxes100,000Earnings after taxes210,000Preferred stock dividends80,000Earnings available to common stockholders130,000Shares outstanding100,000Earnings per share$1.302-5.

23、Lasar Technology, Inc. had sales of $500,000, cost of goods sold of $180,000, selling and administrative expense of $70,000, and operating profit of $90,000. What was the value of depreciation expense? Set this problem up as a partial income statement, and determine depreciation expense as the plug

24、figure.Solution:Lasar Technology, Inc.Sales$500,000Cost of goods sold180,000Gross Profit$320,000Selling and administrative expense70,000Depreciation Expense (plug figure)160,000Operating profit$ 90,0002-6.The Reid Book Company sold 1,500 finance textbooks for $100 each to High Tuition University in

25、2004. These books cost Reid $74 to produce. Reid spent $4,000 (selling expense) to convince the university to buy its books. In addition, Reid borrowed $50,000 on January 1, 2004, on which the company paid 10 percent interest. Both interest and principal of the loan were paid on December 31, 2004. R

26、eids tax rate is 25 percent. Depreciation expense for the year was $8,000.Did Reid Book Company make a profit in 2004? Please verify with an income statement presented in good form.Solution:Reid Book CompanySales (1,500 books at $100 each)$150,000Cost of goods sold (1,500 books at $74 each) 111,000G

27、ross profit$ 39,000Selling expense4,000Depreciation expense 8,000Operating profit$ 27,000Interest expense 5,000Earnings before taxes$ 22,000Taxes 25% 5,500Earnings after taxes$ 16,5002-7.Carr Auto Wholesalers had sales of $900,000 in 2004 and their cost of goods sold represented 65 percent of sales.

28、 Selling and administrative expenses were 9 percent of sales. Depreciation expense was $10,000 and interest expense for the year was $8,000. The firms tax rate is 30 percent.a.Compute earnings after taxes.b.Assume the firm hires Ms. Hood, an efficiency expert, as a consultant. She suggests that by i

29、ncreasing selling and administrative expenses to 12 percent of sales, sales can be increased to $1,000,000. The extra sales effort will also reduce cost of goods sold to 60 percent of sales (there will be a larger makeup in prices as a result of more aggressive selling). Depreciation expense will re

30、main at $10,000. However, more automobiles will have to be carried in inventory to satisfy customers, and interest expense will go up to $15,000. The firms tax rate will remain at 30 percent. Compute revised earnings after taxes based on Ms. Hoods suggestions for Carr Auto Wholesalers. Will her idea

31、s increase or decrease profitability?Solution:Carr Auto WholesalersIncome Statementa.Sales$900,000Cost of goods old (65% of sales)585,000Gross profit315,000Selling and administrative expense (9% of sales)81,000Depreciation 10,000Operating profit224,000Interest expense 8,000Earnings before taxes216,0

32、00Taxes 30% 64,800Earnings after taxes$151,2002-7 Continuedb.Sales$1,000,000Cost of goods sold (60% of sales)600,000Gross profit400,000Selling and administrative expense(12% of sales)120,000Depreciation 10,000Operating profit270,000Interest expense 15,000Earnings before taxes255,000Taxes 30% 76,500E

33、arnings after taxes$ 178,500Ms. Hoods ideas will increase profits.2-8.Classify the following balance sheet items as current or noncurrent.Retained earningsAccounts payablePrepaid expensesPlant and equipment InventoryCommon stockBonds payableAccrued wages payableAccounts receivableCapital in excess o

34、f parPreferred stockMarketable securitiesSolution:Retained earnings noncurrentAccounts payable currentPrepaid expense currentPlant and equipment noncurrentInventory currentCommon stock noncurrentBonds payable noncurrentAccrued wages payable currentAccounts receivable currentCapital in excess of par

35、noncurrentPreferred stock noncurrentMarketable securities current2-9.Arrange the following income statement items so they are in the proper order of an income statement:TaxesShares outstandingInterest expenseDepreciation expensePreferred stock dividendsOperating profitSalesGross profitEarnings per s

36、hareEarnings before taxesCost of goods soldEarnings after taxesEarnings available to common stockholdersSelling and administrative expensesSolution:SalesCost of goods soldGross profitSelling and administrative expenseDepreciation expenseOperating profitInterest expenseEarnings before taxesTaxesEarni

37、ngs after taxesPreferred stock dividendsEarnings Available to Common StockholdersShares OutstandingEarnings per share2-10.Identify whether each of the following items increases or decreases cash flow:Increase in accounts receivableIncrease in notes payableDepreciation expenseIncrease in investmentsD

38、ecrease in accounts payableDecrease in prepaid expensesIncrease in inventoryDividend paymentIncrease in accrued expensesSolution:Increase in accounts receivable decreases cash flow (use)Increase in notes payable increases cash flow (source)Depreciation expense increases cash flow (source)Increase in

39、 investments decreases cash flow (use)Decrease in accounts payable decreases cash flow (use)Decrease in prepaid expense increases cash flow (source)Increase in inventory decreases cash flow (use)Dividend payment decreases cash flow (use)Increase in accrued expenses increases cash flow (source)2-11.E

40、lite trailor parks has an operating profit of $200,000. Interest expense for the year was $10,000; preferred dividends paid were $18,750; and common dividends paid were $30,000. The tax was $61,250. The firm has 20,000 shares of common stock outstanding.a.Calculate the earnings per share and the com

41、mon dividends per share for Elite trailor parks.b.What was the increase in retained earnings for the year?Solution:Elite Trailor Parksa.Operating profit (EBIT)$200,000Interest expense 10,000Earnings before taxes (EBT)$190,000Taxes 61,250Earnings after taxes (EAT)$128,750Preferred dividends 18,750Ava

42、ilable to common stockholders$110,000Common dividends 30,000Increase in retained earnings$ 80,000b.Increase in retained earnings = $80,0002-12.Johnson Alarm Systems had $800,000 of retained earnings on December 31, 2004. The company paid dividends of $60,000 in 2004 and had retained earnings of $640

43、,000 on December 31, 2003. How much did Johnson earn during 2004, and what would earnings per share be if 50,000 shares of common stock were outstanding?Solution:Johnson Alarm SystemsRetained earnings, December 31, 2004$800,000Less: Retained earnings, December 31, 2003640,000Change in retained earni

44、ngs$160,000Add: Common stock dividends60,000Earnings available to common stockholders$220,000Earnings per share2-13.Nova Electrics anticipated cash flow from operating activities of $6 million in 2005. It will need to spend $1.2 million on capital investments in order to remain competitive within th

45、e industry. Common stock dividends are projected at $.4 million and preferred stock dividends at $.55 million.a.What is the firms projected free cash flow for the year 2005?b.What does the concept of free cash flow represent?Solution:Nova Electronicsa.Cash flow from operations activities$6.00million

46、- Capital Expenditures1.20- Common stock dividends.40- Preferred stock dividends .55 Free cash flow$3.85millionb.Free cash flow represents the funds that are available for special financial activities, such as a leveraged buyout, increased dividends, common stock repurchases, acquisitions, or repaym

47、ent of debt.2-14.Fill in the blank spaces with categories 1 through 7 below:1.Balance sheet (BS).5.Current liabilities (CL).2.Income statement (IS).6.Long-term liabilities (LL).3.Current assets (CA).7.Stockholders equity (SE).4.Fixed assets (FA).Indicate Whether Item is on Balance Sheet (BS) or Inco

48、me Statement (IS)_If on Balance Sheet, Designate Which Category_ItemAccounts receivable Retained earningsIncome tax expenseAccrued expensesCashSelling and administrative expensesPlant and equipmentOperating expenseMarketable securitiesInterest expenseSalesNotes payable (6 months)Bonds payable, matur

49、ity 2001Common stockDepreciation expenseInventoriesCapital in excess of par valueNet income (earnings after taxes)Income tax payableSolution:1.Balance Sheet (BS)2.Income Statement (IS)3.Current Assets (CA)4.Fixed Assets (FA)5.Current Liabilities (CL)6.Long-Term Liabilities (LL)7.Stockholders Equity

50、(SE)2-14. ContinuedIndicate Whether the item is on Income Statement or Balance SheetIf the Item is on Balance Sheet, Designate Which CategoryItemBSCAAccounts ReceivableBSSERetained EarningsISIncome Tax ExpenseBSCLAccrued ExpensesBSCACashISSelling and Administrative ExpensesBSFAPlant & EquipmentISOpe

51、rating ExpensesBSCAMarketable SecuritiesISInterest ExpenseISSalesBSCLNotes Payable (6 months)BSLLBonds payable (Maturity 2009)BSSECommon StockISDepreciation ExpenseBSCAInventoriesBSSECapital in excess of par valueISNet Income (Earnings after Taxes)BSCLIncome tax payable2-15.The Rogers Corporation ha

52、s a gross profit of $880,000 and $360,000 in depreciation expense. The Evans Corporation also has $880,000 in gross profit, with $60,000 in depreciation expense. Selling and administrative expense is $120,000 for each company.Given that the tax rate is 40 percent, compute the cash flow for both comp

53、anies. Explain the difference in cash flow between the two firms.Solution:Rogers Corporation Evans CorporationRogersEvansGross profitSelling and adm. expenseDepreciationOperating profitTaxes (40%)Earnings after taxesPlus depreciation expenseCash Flow$880,000120,000360,000$880,000120,00060,000$400,00

54、0160,000$700,000280,000$240,000$360,000$420,000$60,000$600,000$480,000Rogers had $300,000 more in depreciation which provided $120,000 (0.40 x $300,000) more in cash flow.2-16.Arrange the following items in proper balance sheet presentation.Accumulated depreciation$200,000Retained earnings110,000Cas

55、h5,000Bonds payable142,000Accounts receivable38,000Plant and equipmentoriginal cost720,000Accounts payable35,000Allowance for bad debts6,000Common stock $1 par, 150,000 shares outstanding150,000Inventory66,000Preferred stock, $50 par, 1,000 shares outstanding50,000Marketable securities15,000Investme

56、nts20,000Notes payable83,000Capital paid in excess of par (common stock)88,000Solution:AssetsCurrent Assets:CashMarketable securitiesAccounts receivableLess: Allowance for bad debtsInventoryTotal Current AssetsOther Assets:InvestmentsFixed Assts:Plant and equipmentLess: Accumulated depreciationNet p

57、lant and equipmentTotal Assets$ 38,000 6,000$720,000 200,000$ 5,00015,00032,000 66,000$118,00020,000 520,000$658,0002-16. ContinuedLiabilities and Stockholders EquityCurrent Liabilities:Accounts payableNotes payableTotal current liabilitiesLong-term LiabilitiesBonds payableTotal LiabilitiesStockhold

58、ers Equity:Preferred stock, $50 par, 1,000 shares outstandingCommon stock, $1 par, 150,000 shares outstandingCapital paid in excess of par (common stock)Retained earningsTotal Stockholders EquityTotal Liabilities and Stockholders Equity$ 35,000 83,000$118,000 142,000$260,00050,000150,00088,000 110,0

59、00$398,000$658,0002-17.Horton Electronics has current assets of $320,000 and fixed assets of $640,000. Current liabilities are $90,000 and long-term liabilities are $160,000. There is $90,000 in preferred stock outstanding and the firm has issued 40,000 shares of common stock. Compute book value (ne

60、t worth) per share.Solution:Horton Energy CompanyCurrent assetsFixed assetsTotal assetsCurrent liabilitiesLong-term liabilitiesStockholders equityPreferred stock obligationNet worth assigned to commonCommon shares outstandingBook value (net worth) per share$320,000 640,000$960,00090,000 160,000$710,