1、Copyright 2005 by The McGraw-Hill Companies, Inc. S-4Chapter 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-equit
2、y structure of the firm, the dividend payment policy, 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 pe
3、r share? Why does this disparity occur?Book value per share 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
4、 current assessed value of the firm in the marketplace 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 i
5、ndustry outlook. To the extent these are quite negative 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
6、income. This non-cash deduction may provide cash flow equal 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 depreciat
7、ion is the sum of all past and present depreciation charges, 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).Copyright 200
8、5 by The McGraw-Hill Companies, Inc.S-52-5. How is the income statement related to the balance sheet?The earnings (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 pa
9、rt of the ownership interest in the balance sheet.2-6. Comment on why inflation may restrict the usefulness of 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 p
10、lant and equipment and inventory.2-7. Explain why the statement of cash flows provides useful information that goes 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 th
11、e period in which they occur. However, accrual accounting does not attempt to properly assess the cash flow position 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 divide
12、nd be shown?The sections of the statement of cash flows are:Cash flows from operating activitiesCash flows from investing activitiesCash flows from financing activitiesThe payment of cash dividends falls into the financing activities category.Copyright 2005 by The McGraw-Hill Companies, Inc. S-62-9.
13、 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 maintain the productive capacity of the firm.Minus: Dividends (required to maintain the payout on common stock and to cover any pre
14、ferred 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 with the leveraged buy-out.2-10. Why is interest expense said to cost the firm substantially less than the actual expense, while di
15、vidends 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 of interest expense is the amount paid multiplied by the difference of one minus the applicable tax rate.For example, $100 of inter
16、est 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 taxes of $580,000 in the year 2003 with 400,000 shares outstanding. On January 1, 2004, the firm issued 35,000 new shares. Becau
17、se 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. Compute earnings per share for the year 2004.Solution:Rockwell Paper Companya. Year 2003Copyright 2005 by The McGraw-Hill Compani
18、es, Inc.S-745.1$0,458goutsandi Shrefr xeEisaper Earnigb. Year 2004 67.1$0,43572sharep Earnig 0,435,outdi Sre 2.safxeisCopyright 2005 by The McGraw-Hill Companies, Inc. S-82-2. Given the following information, prepare, in good form, an income statement for the Goodman Software, Inc.Selling and admini
19、strative expense $ 50,000Depreciation expense 80,000Sales 400,000Interest expense 30,000Cost of goods sold 150,000Taxes 18,550Solution:Goodman Software, Inc.Sales $ 400,000Cost of goods sold 150,000Gross Profit 250,000Selling and administrative expense 50,000Depreciation expense 80,000Operating prof
20、it 120,000Interest expense 30,000Earnings before taxes 90,000Taxes 18,550Earnings after taxes $ 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 ind
21、ustry had a gross profit of 60 percent, how is the firm doing?Solution:Kevin Bacon and Port Companya. Sales $240,000Cost of goods sold 180,000Gross profit $132,000SalesprofitG%50,2413$b. With a gross profit 55 percent, the firm is under-performing the industry average of 60 percent.Copyright 2005 by
22、 The McGraw-Hill Companies, Inc.S-92-4. Prepare in good form an income statement for Virginia Slim Wear. Take your calculations all the way to computing earnings per share.Sales $600,000Shares outstanding 100,000Cost of goods sold 200,000Interest expense 30,000Selling and administrative expense 40,0
23、00Depreciation expense 20,000Preferred stock dividends 80,000Taxes 100,000Solution:Virginia Slim WearIncome StatementSales $600,000Cost of goods sold 200,000Gross profit 400,000Selling and administrative expense 40,000Depreciation expense 20,000Operating profit 340,000Interest expense 30,000Earnings
24、 before taxes 310,000Taxes 100,000Earnings after taxes 210,000Preferred stock dividends 80,000Earnings available to common stockholders 130,000Shares outstanding 100,000Earnings per share $1.302-5. Lasar Technology, Inc. had sales of $500,000, cost of goods sold of $180,000, selling and administrati
25、ve 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 figure.Solution:Lasar Technology, Inc.Sales $500,000Cost of goods sold 180,000Gross Profit $320,000Sel
26、ling and administrative expense 70,000Depreciation Expense (plug figure) 160,000Operating profit $ 90,000Copyright 2005 by The McGraw-Hill Companies, Inc. S-102-6. The Reid Book Company sold 1,500 finance textbooks for $100 each to High Tuition University in 2004. These books cost Reid $74 to produc
27、e. 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. Reids tax rate is 25 percent. Depreciation
28、 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) 111,000Gross profit $ 39,000Selling expense 4,00
29、0Depreciation 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. Selling and administrative expens
30、es 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 increasing selling and administra
31、tive 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 remain at $10,000. However, more a
32、utomobiles 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 ideas increase or decrease profitabi
33、lity?Solution:Carr Auto WholesalersIncome StatementCopyright 2005 by The McGraw-Hill Companies, Inc.S-11a. Sales $900,000Cost of goods old (65% of sales) 585,000Gross profit 315,000Selling and administrative expense (9% of sales) 81,000Depreciation 10,000Operating profit 224,000Interest expense 8,00
34、0Earnings before taxes 216,000Taxes 30% 64,800Earnings after taxes $151,2002-7 Continuedb. Sales $1,000,000Cost of goods sold (60% of sales) 600,000Gross profit 400,000Selling and administrative expense(12% of sales) 120,000Depreciation 10,000Operating profit 270,000Interest expense 15,000Earnings b
35、efore taxes 255,000Taxes 30% 76,500Earnings 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 payable
36、Accounts receivableCapital in excess of parPreferred stockMarketable securitiesSolution:Retained earnings noncurrentAccounts payable currentPrepaid expense currentPlant and equipment noncurrentInventory currentCommon stock noncurrentBonds payable noncurrentAccrued wages payable currentAccounts recei
37、vable currentCopyright 2005 by The McGraw-Hill Companies, Inc. S-12Capital in excess of par 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 expens
38、eDepreciation expensePreferred stock dividendsOperating profitSalesGross profitEarnings per shareEarnings before taxesCost of goods soldEarnings after taxesEarnings available to commonstockholdersSelling and administrative expensesSolution:SalesCost of goods soldGross profitSelling and administrativ
39、e expenseDepreciation expenseOperating profitInterest expenseEarnings before taxesTaxesEarnings after taxesPreferred stock dividendsEarnings Available to Common StockholdersShares OutstandingEarnings per share2-10. Identify whether each of the following items increases or decreases cash flow:Increas
40、e in accounts receivableIncrease in notes payableDepreciation expenseIncrease in investmentsDecrease in accounts payableDecrease in prepaid expensesIncrease in inventoryDividend paymentIncrease in accrued expensesSolution:Increase in accounts receivable decreases cash flow (use)Copyright 2005 by The
41、 McGraw-Hill Companies, Inc.S-13Increase in notes payable increases cash flow (source)Depreciation expense increases cash flow (source)Increase in investments decreases cash flow (use)Decrease in accounts payable decreases cash flow (use)Decrease in prepaid expense increases cash flow (source)Increa
42、se in inventory decreases cash flow (use)Dividend payment decreases cash flow (use)Increase in accrued expenses increases cash flow (source)2-11. Elite 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 divi
43、dends 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 common dividends per share for Elite trailor parks.b. What was the increase in retained earnings for the year?Solution:Elite Trailor Parksa. Operating prof
44、it (EBIT) $200,000Interest expense 10,000Earnings before taxes (EBT) $190,000Taxes 61,250Earnings after taxes (EAT) $128,750Preferred dividends 18,750Available to common stockholders $110,000Common dividends 30,000Increase in retained earnings $ 80,000Copyright 2005 by The McGraw-Hill Companies, Inc
45、. S-14sharep 50.1$s ,2/,3Sharep Divdenssharep 50.$s ,2/,1 gOutsandiStock Cm.f Share ofNumbrhletAvilErnigsb. 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 earnin
46、gs of $640,000 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, 2003 640,000Change in re
47、tained earnings $160,000Add: Common stock dividends 60,000Earnings available to common stockholders $220,000Earnings per share sharep 40.$,522-13. 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
48、to remain competitive within the 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?Copyright 2005 by The McGraw-Hill Companie
49、s, Inc.S-15Solution:Nova Electronicsa. Cash flow from operations activities $6.00 million- Capital Expenditures1.20- Common stock dividends .40- Preferred stock dividends .55Free cash flow $3.85 millionb. 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 repayment of debt.2-14. Fill in the blank spaces with categories 1 through 7 below:1.
