Professional Documents
Culture Documents
Q1-1.
Q1-2.
Q1-3.
Solutions Manual
Q1-4.
Q1-5.
Q1-6.
Q1-7.
Q1-8.
Q1-9.
Solutions Manual
Solutions Manual
Q1-16.
Solutions Manual
Q1-17.
Q1-18.
Solutions Manual
M1-21
($ millions)
Hewlett-Packard
General Mills
Target
Assets
Liabilities
Equity
$124,503
$83,722
(a) $40,781
$18,674
(b) $12,062
$6,612
(c) $43,705
$28,218
$15,487
General Mills and Target are more owner financed, while Hewlett-Packard is
more nonowner financed, but all are financed with roughly the same level
of debt and equity. All three enjoy relatively stable cash flows and can,
therefore, utilize a greater proportion of debt vs. equity. As the uncertainty
of cash flows increases, companies generally substitute equity for debt in
order to reduce the magnitude of contractual payment obligations.
M1-24
a. BS and SCF
d. BS and SE
g. SCF and SE
b. IS
e. SCF
h. SCF and SE
c. BS
f. BS and SE
Solutions Manual
E1-27
a. Target has a proprietary credit card (the Target Card). Customers
unpaid credit card balances at the end of the reporting period are similar
to accounts receivable.
b. Targets inventories consist of the product lines it carries: clothing,
electronics, home furnishings, food products, and so forth.
c. Targets PPE assets consist of land, buildings, store improvements
such as lighting, flooring, HVAC, store shelving, shopping carriages,
and cash registers.
d. Although Target sells some of its merchandise via its Website, the
majority of its sales activity is conducted in its retail locations. These
stores represent a substantial and necessary capital investment for its
business model.
Solutions Manual
P1-36
a.
General Mills, Inc.
Income Statement ($ millions)
For Year Ended May 29, 2011
Revenue ............................................................................... $14,880.2
Cost of goods sold ..............................................................
8,926.7
Gross profit ..........................................................................
5,953.5
Total expenses ....................................................................
4,155.2
Net income ........................................................................... $ 1,798.3
$ 1,526.8
(715.1)
(865.3)
(53.6)
673.2
$ 619.6
Solutions Manual
P1-47A
Solutions Manual
D1-53
Financing can come from a number of sources, including operating
creditors, borrowed funds, and the sale of stock. Each has its strengths
and weaknesses.
1. Operating creditors operating creditors are merchandise and service
suppliers, including employees. Generally, these liabilities are noninterest bearing. As a result, companies typically use this source of
credit to the fullest extent possible, often stretching payment times.
However, abuse of operating creditors has a significant downside. The
company may be unable to supply its operating needs and the damage
to employee morale might have significant repercussions. Operating
credit must, therefore, be used with care.
2. Borrowed funds borrowed money typically carries an interest rate.
Because interest expense is deductible for tax purposes, borrowed
funds reduce income tax expense. The taxes saved are called the tax
shield. The deductibility of interest reduces the effective cost of
borrowing. The downside of debt is that the company must make
principal and interest payments as scheduled. Failure to make payments
on time can result in severe consequences creditors have significant
legal remedies, including forcing the company into bankruptcy and
requiring its liquidation. The lower cost of debt must be balanced
against the fixed payment obligations.
3. Sale of stock companies can sell various classes of stock to investors.
Some classes of stock have mandatory dividend payments. On other
classes of stock, dividends are not a legal requirement until declared by
the board of directors. Consequently, unlike debt payments, some
dividends can be curtailed in business downturns. The downside of
stock issuance is its cost. Because equity is the most expensive source
of capital, companies use it sparingly.
Solutions Manual
Module 2
Q2-1.
Cash
Receivables
Inventories
Plant, property and equipment (PPE)
Liabilities
Accounts payable
Accrued liabilities
Deferred revenue
Notes payable
Long-term debt
Equity
Q2-2.
Q2-3.
Solutions Manual
Transitory items are revenues and expenses that are not expected
to recur. One objective of financial analysis is to predict future
performance. Given that perspective, transitory (nonrecurring)
items are not relevant except to the extent that they convey
information about future financial performance.
Q2-5.
Q2-6.
Q2-7.
Articulation refers to the fact that the four financial statements are
linked to each other and that changes in one statement affect the
other three. For example, net income reported on the income
statement is linked to the statement of retained earnings, which in
turn is linked to the balance sheet. Understanding how the
financial statements articulate helps us to analyze transactions
and events and to understand how events affect each financial
statement separately and all four together.
Q2-8.
Solutions Manual
Q2-10.
Liquidity refers to the ready availability of cash. That is, how much
cash the company has on hand, how much cash is being
generated, and how much cash can be raised quickly. Liquidity is
essential to the survival of the business. After all, firms must pay
loans and employee wages with cash.
Q2-11.
Q2-12.
GAAP uses historical costs because they are less subjective than
market values. Market values can be biased for two reasons: first,
we may not be able to measure them accurately (consider our
inability to accurately measure the market value of a
manufacturing facility, for example), and second, managers may
intervene in the reporting process to intentionally bias the results
to achieve a particular objective (like enhancing the stock price).
Q2-13.
Solutions Manual
Q2-14.
Q2-15.
Q2-16.
Solutions Manual
M2-20
a. Balance sheet
b. Income statement
c. Balance sheet
d. Income statement
e. Balance sheet
f. Balance sheet
g. Balance sheet
h. Balance sheet
i. Income statement
j. Income statement
k. Balance sheet
l. Balance sheet
Solutions Manual
M2-23
2011
Beginning retained earnings ..............................$89,089
Add: Net income (loss) ..................................... (19,455)
Less: Dividends ...................................................
0
Ending retained earnings ....................................$69,634
2012
$ 69,634
48,192
(15,060)
$102,766
E2-27
Barth Company
Income Statement
For Year Ended December 31, 2011
Sales revenue .................................................................
Expenses
Cost of goods sold .....................................................
$180,000
Wages expense .......................................................... 40,000
Supplies expense ....................................................... 6,000
Total expenses ...........................................................
Net income......................................................................
$400,000
226,000
$174,000
Barth Company
Balance Sheet
December 31, 2011
Assets
Liabilities and equity
Cash ....................................$ 48,000 Accounts payable ........................................................
$ 16,000
Accounts receivable .......... 30,000 Bonds payable .............................................................
200,000
Supplies inventory ............. 3,000 Total liabilities ..............................................................
216,000
Inventory ............................. 36,000
Land .................................... 80,000 Common stock .............................................................
150,000
Equipment .......................... 70,000 Retained earnings .......................................................
60,000
Buildings.............................151,000 Total equity...................................................................
210,000
Goodwill .............................. 8,000
Total assets ........................
$426,000 Total liabilities and equity ...........................................
$426,000
Solutions Manual
P2-39
a.
Balance Sheet
Income Statement
LiabilTransaction
Beginning bal.
Cash
Asset
0
Noncash
Assets
ities
+150,000
1. Sefcik invested $50,000
into the business in
exchange for common
stock; company also
borrowed $100,000
from a bank
2. Sefcik purchased
equipment for $95,000
cash and purchased
inventory of $40,000 on
credit
Cash
-95,000
+95,000
Cash
PPE
+100,000
+50,000
Note
Common
Payable
Stock
=
+40,000
+40,000
Accounts
Inventory
Payable
Solutions Manual
Earned
Contrib.
Capital
Capital
0
Net
Revenues
Expenses
=
Income
P2-39 (continued)
Balance Sheet
Income Statement
LiabilTransaction
Cash
Asset
Noncash
Assets
Earned
=
ities
Contrib.
Capital
Capital
+50,000
Net
Revenues
Expenses
=
Income
+50,000
+50,000
Cash
Sales
+50,000
Retained
3. Sefcik Co.
sold
inventory
costing
$30,000
for
$50,000
cash
Earnings
=
-30,000
-30,000
Inventory
Retained
Solutions Manual
=
-30,000
Cost of
Goods
Sold
Earnings
4. Sefcik Co.
paid
-10,000
$10,000
cash for
Cash
wages
owed
employees
for
October
work
5. Sefcik Co.
paid
-1,000
interest on
the bank
Cash
loan of
$1,000
cash
+30,000
-10,000
+10,000
-10,000
Retained
Wage
Earnings
Expense
-1,000
+1,000
-1,000
=
Retained
Earnings
Interest
Expense
P2-39 (continued)
Balance Sheet
Income Statement
LiabilTransaction
Cash
Asset
Earned
=
ities
Contrib.
Capital
Capital
Net
Revenues
-500
6. Sefcik Co.
recorded $500
depreciation
expense
related to
equipment
7. Sefcik Co.
paid
a dividend of
$2,000 cash
Noncash
Assets
Expenses
=
Income
+500
-500
=
Retained
Deprec.
-500
PPE
Earnings
-2,000
Exp
-2,000
=
Cash
Dividends
104,500
= 140,000
50,000
6,500
50,000
41,500
8,500
b.
b.
Sefcik Co.
Income Statement
For Month of October
Sales revenue .........................................................................................
$50,000
Total expenses .......................................................................................
41,500
Net income..............................................................................................
$ 8,500
Sefcik Co.
Retained Earnings Reconciliation
For Month of October
Retained earnings, October 1 .............................................................
$
0
Add: Net income ................................................................................ 8,500
Less: Dividends ..................................................................................(2,000)
Retained earnings, October 31 ...........................................................
$ 6,500
Sefcik Co.
Balance Sheet
October 31
Cash ....................................
$ 92,000 Liabilities .......................................................................
$140,000
Noncash assets..................
104,500
Contributed capital .......................................................
50,000
Retained earnings .........................................................
6,500
________ Total equity ....................................................................
56,500
Total assets ........................
$196,500 Total liabilities and equity ............................................
$196,500
Solutions Manual
P2-43
a. Depreciation is added back to undo the effect it had on the income
statement. Wal-Mart deducted $7,641 million of depreciation (and
amortization) expense in computing net income. Depreciation is a
noncash expense so Wal-Mart did not actually use $7,641 million of cash
to pay depreciation expense. Thus, to determine how much cash was
generated, net income is too low by the depreciation amount of $7,641
million. The depreciation add-back is NOT a source of cash as some
mistakenly believe. Cash is, ultimately, generated by profitable
operations, not by depreciation.
b. Revenue is recognized, and profit increased, when it is earned, whether
or not cash is received. Sales on account, therefore, increase profit, and
the deduction for the increase in receivables reflects the fact that cash
has not yet been received.
The negative sign on the increase in inventories reflects the outflow of
cash when inventories are purchased. Inventories are typically
purchased on account. As a result, payment is not made when the
inventories are purchased. The positive sign on the increase in
accounts payable offsets a portion of the negative sign on the inventory
increase, and the net amount represents the net cash paid for the
increase in inventories. Accounts payable are typically non-interest
bearing, thus providing a cheap and important source of cash.
Accruals relate to expenses that have been recognized in the income
statement that have not yet been paid. A decrease in accrued liabilities
means that cash paid out for expenses during the year was greater than
the expenses recognized in the income statement.
Therefore, a
decrease in accrued expenses is shown as a cash outflow.
c. Companies must continue to invest in their infrastructure, both for new
additions and replacement, to remain competitive. Depreciation expense
represents the using up of depreciable assets. In general, we should
expect capital expenditures (CAPEX) to exceed depreciation expense.
This indicates that the company is growing its infrastructure as well as
replacing the portion that is wearing out.
Solutions Manual
P2-43 (concluded)
d. If Wal-Mart can make a better return on reinvesting its cash back into the
business than the return shareholders can earn for themselves on the
cash they would receive, Wal-Mart should forgo paying dividends or
repurchasing shares. Many companies with large cash inflows,
especially mature companies in relatively saturated markets, find it hard
to uncover additional investment opportunities. In those cases,
returning the cash to investors is better than investing it in marketable
securities, because investors can do that for themselves.
e. Wal-Mart is a large, mature, and profitable company. In fiscal 2011, the
company generated 39% more operating cash flows than reported
profits; $23.6 billion of operating cash flow compared to $17.0 billion in
net income. It funds capital expenditures for new stores and remodels
with operating cash flows with no need for external financing. In the
financing area, the company is borrowing to repurchase stock and to
pay dividends, a substitution of lower-cost debt for higher-cost equity.
This is a typical profile for a large, well-capitalized company like WalMart. In sum, Wal-Mart is exceptionally strong, and the company will
likely continue investing in its infrastructure.
Solutions Manual
Module 3
Q3-1.
Q3-2.A
Q3-3.
Q3-4.
Solutions Manual
Q3-5.
Q3-6.
Q3-7.A
Solutions Manual
Q3-9.
Q3-10.
Q3-11.
Q3-12.
Solutions Manual
M3-20B
($ millions)
a. ROE
= Net income / Average equity
= $847 / [($5,530 + $4,653)/2]
= 16.64%
b. PM
AT
FL
ROA
P3-36
($ millions)
a. 2010 NOPAT = $5,918 - [$1,592 + ($163 0.37)] = $4,266
b. 2010 NOA =
($30,156 - $3,377 - $1,101- $540 - $146) - ($6,089 - $1,269) - $2,013 - $1,854
= $16,305
2009 NOA
= ($27,250 - $3,040 - $744 - $825 - $103) - ($4,897 - $613) - $2,227 - $1,727
= $14,300
c. 2010 RNOA = $4,266 / [($16,305 + $14,300) / 2] = 27.88%
Solutions Manual
P3-39
($ millions)
2010 NOA
Solutions Manual
P3-39 (concluded)
e. 2011 ROE = $1,277 / [($6,602 + $6,320) / 2] = 19.76%
f. 2011 nonoperating return = ROE RNOA = 19.76% - 18.86% = 0.90%
g.
ROE > RNOA implies that Best Buy is able to borrow money to
fund operating assets that yield a return greater than the cost of
its debt. The excess accrues to the benefit of BBYs stockholders.
D3-55
a. Raising prices and/or reducing manufacturing costs are not necessarily
independent solutions, and are likely related to other factors. The effect
of a price increase on gross profit is a function of the demand curve for
the companys product. If the demand curve is relatively elastic,
customers are sensitive to price hikes. Thus, a price increase could
significantly reduce demand, thereby decreasing, rather than increasing,
gross profit (an example is a 10% increase in price and a 20% decrease
in demand). A price increase will have a more desired effect if the
demand curve is relatively inelastic (an example is a 10% price increase
with a 3% decrease in demand).
Cutting manufacturing costs will increase gross profit (via reduction of
COGS) if the more inexpensively made product is not perceived to be of
lesser quality, thereby reducing demand.
b. Raising prices is difficult in competitive markets. As the number of
product substitutes increases, companies are less able to raise prices.
Rather, they must be able to effectively differentiate their products in
some manner in order to reduce consumers substitution. This can be
accomplished, for example, by product design and/or advertising. These
efforts, however, likely entail additional cost, and, while gross profit
might be increased as a result, SG&A expense may also increase with
little effect on the bottom line.
Manufacturing costs consist of raw materials, labor and overhead. Each
can be targeted for cost reduction. A reduction of raw materials costs
generally implies some reduction in product quality, but not necessarily.
It might be the case that the product contains features that are not in
demand by consumers. Eliminating those features will reduce product
costs with little effect on selling price.
Solutions Manual
Similarly, companies can utilize less expensive sources of labor (offshore production, for example), that can significantly reduce product
costs and increase gross profit, provided that product quality is
maintained.
Finally, manufacturing overhead can be reduced by more efficient
production. Wages and depreciation expense are two significant
components of manufacturing overhead. These are largely fixed costs,
and the per unit product cost can often be reduced by increasing
capacity utilization of manufacturing facilities (provided, of course, that
the increased inventory produced can be sold).
The bottom line is that increasing gross profit is a difficult process that
can only be accomplished by effective management and innovation.
D3-56
a. Working capital management is an important component of the
management of a company. By reducing the level of working capital,
companies reduce the costs of carrying excess assets. This can have a
significantly positive effect on financial performance. Common ways to
decrease receivables and inventories, and increase payables, include
the following:
Reduce receivables
Reduce inventories
Reduce inventory costs via less costly components (of equal quality), produce
with lower wage rates, eliminate product features (costs) not valued by
customers
Outsource production to reduce product cost and/or inventories the company
must carry on its balance sheet
Reduce raw materials inventories via just-in-time deliveries
Solutions Manual
Increase payables
Extend the time for payment of low or no-cost payablesso long as the
relationship with suppliers is not harmed
Solutions Manual
Solutions Manual
Module 4
Q4-1.
Q4-2.
Q4-3.
Solutions Manual
Q4-5.
Solutions Manual
Q4-6.
Q4-7.
Solutions Manual
Q4-9.
Q4-10.
Two factors impact credit risk: potential for default, and the
magnitude of loss given a default.
Chance of default can be measured via credit analysis, which
attempts to capture the probability that a company will not
generate cash flows great enough to meet its obligations.
The magnitude of loss captures the likelihood of receiving
compensation when the company defaults. The magnitude of
recovery can be based on the seniority of the debt in question
Solutions Manual
amongst the other creditors that the company owes money. In the
case of a junior claim, the loss given default is commonly the
entire amount borrowed, whereas a more senior claim may recoup
most if not all of its loan.
Q4-11.
Q4-12.
Q4-13.
Solutions Manual
M4-17
Pfizer, Inc., (PFE) demonstrates marked improvement in almost all aspects
of financial health, making the company less risky to creditors in 2006. Its
2006 liquidity ratios (both current and quick) are higher than the prior year.
In terms of solvency, leverage decreased in 2006, as the company seems to
be drawing upon equity financing more than debt financing according to its
liabilities-to-equity and long-term debt-to-equity ratios.
Finally, although its factor of times interest earned decreased marginally, it
is still clearly covering all interest expenses associated with debt
obligations (nearly 30 times over), and its cash from operations to total
debt and free operating cash flow to total debt increased markedly from
2005 to 2006.
E4-27
a.
Solutions Manual
P4-31
a. 2005 current ratio = $10,529 / $9,428 = 1.12
2004 current ratio = $8,953 / $8,566 = 1.05
2005 quick ratio = ($2,244 + $429 + $4,579) / $9,428 = 0.77
2004 quick ratio = ($1,060 + $396 + $4,094) / $8,566 = 0.65
Lockheed Martin is fairly liquid. Both the current and quick ratios have
increased during 2005, but neither is particularly high.
b. 2005 total liabilities to stockholders equity
= ($9,428 + $4,784 + $2,097 + $1,277 + $2,291) / $7,867 = 2.53
2004 total liabilities to stockholders equity
= ($8,566 + $5,104 + $1,660 + $1,236 + $1,967) / $7,021 = 2.64
Solutions Manual
2005 cash from operations to total debt = $3,194 / ($202 + $4,784) = 0.64
2004 cash from operations to total debt = $2,924 / ($ 15 + $5,104) = 0.57