SM Garrison MGR Acc 13e Ch16

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Chapter 16
How Well Am I Doing?
Financial Statement Analysis
Solutions to Questions
16-1 Horizontal analysis examines how a particular item on a financial statement such as
sales or cost of goods sold behaves over time.
Vertical analysis involves analysis of items on an
income statement or balance sheet for a single
period. In vertical analysis of the income statement, all items are typically stated as a percentage of sales. In vertical analysis of the balance
sheet, all items are typically stated as a percentage of total assets.
16-2 By looking at trends, an analyst hopes
to get some idea of whether a situation is improving, remaining the same, or deteriorating.
Such analyses can provide insight into what is
likely to happen in the future. Rather than looking at trends, an analyst may compare one
company to another or to industry averages using common-size financial statements.
16-3 Price-earnings ratios reflect investors
expectations concerning future earnings. The
higher the price-earnings ratio, the greater the
growth in earnings investors expect. For this
reason, two companies might have the same
current earnings and yet have quite different
price-earnings ratios. By definition, a stock with
current earnings of $4 and a price-earnings ratio
of 20 would be selling for $80 per share.
16-4 A rapidly growing tech company would
probably have many opportunities to make investments at a rate of return higher than stockholders could earn in other investments. It
would be better for the company to invest in
such opportunities than to pay out dividends
and thus one would expect the company to have
a low dividend payout ratio.
16-5 The dividend yield is the dividend per

share divided by the market price per share. The
other source of return on an investment in stock
is increases in market value.
16-6 Financial leverage results from borrowing funds at an interest rate that differs from the
rate of return on assets acquired using those
funds. If the rate of return on the assets is higher than the interest rate at which the funds were
borrowed, financial leverage is positive and
stockholders gain. If the return on the assets is
lower than the interest rate, financial leverage is
negative and the stockholders lose.
16-7 If the company experiences big variations in net cash flows from operations, stockholders might be pleased that the company has
no debt. In hard times, interest payments might
be very difficult to meet.
On the other hand, if investments within
the company can earn a rate of return that exceeds the interest rate on debt, stockholders
would get the benefits of positive leverage if the
company took on debt.
16-8 The market value of a share of common
stock often exceeds the book value per share.
Book value represents the cumulative effects on
the balance sheet of past activities, evaluated
using historical prices. The market value of the
stock reflects investors expectations about the
companys future earnings. For most companies,
market value exceeds book value because investors anticipate future earnings growth.
16-9 A 2 to 1 current ratio might not be adequate for several reasons. First, the composition
of the current assets may be heavily weighted
toward slow-turning and difficult-to-liquidate
The McGraw-Hill Companies, Inc., 2010

908
Managerial Accounting, 13th Edition
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inventory, or the inventory may contain large

amounts of obsolete goods. Second, the receivables may be low quality, including large
amounts of accounts that may be difficult to
collect.
The McGraw-Hill Companies, Inc., 2010. All rights reserved.

Solutions Manual, Chapter 16
909
Exercise 16-1 (15 minutes)

1.
Sales.....................................................
Cost of goods sold .................................
Gross margin .........................................
Selling and administrative expenses:
Selling expenses .................................
Administrative expenses ......................
Total selling and administrative expenses
Net operating income.............................
Interest expense ...................................
Net income before taxes ........................
This Year Last Year

100.0 %
62.3
37.7
100.0%
58.6
41.4
18.5
8.9
27.4
10.3
1.2
9.1 %
18.2
10.3
28.5
12.9
1.4
11.5%
2. The companys major problem seems to be the increase in cost of goods

sold, which increased from 58.6% of sales last year to 62.3% of sales
this year. This suggests that the company is not passing the increases in
costs of its products on to its customers. As a result, cost of goods sold
as a percentage of sales has increased and gross margin has decreased.
This change has been offset somewhat by reduction in administrative
expenses as a percentage of sales. Note that administrative expenses
decreased from 10.3% to only 8.9% of sales over the two years. However, this decrease was not enough to completely offset the increased
cost of goods sold, so the companys net income decreased as a percentage of sales this year.

910

1. Calculation of the gross margin percentage:
Gross margin
Sales
$27,000
=
= 34.2%
$79,000
Gross margin percentage =
2. Calculation of the earnings per share:

Net income - Preferred dividends
Average number of common
shares outstanding
$3,540 - $120
=
= $4.28 per share
800 shares
Earnings per share =
3. Calculation of the price-earnings ratio:

Market price per share
Earnings per share
$18
=
= 4.2
$4.28
Price-earnings ratio =
4. Calculation of the dividend payout ratio:

Dividends per share
Earnings per share
$0.25
=
= 5.8%
$4.28
Dividend payout ratio =
5. Calculation of the dividend yield ratio:

Dividends per share
$0.25
=
= 1.4%
$18.00
Dividend yield ratio =

911
Exercise 16-2 (continued)

6. Calculation of the return on total assets:
Beginning balance, total assets (a) ....... $45,960
Ending balance, total assets (b) ...........
50,280
Average total assets [(a) + (b)]/2 ........ $48,120
Net income +
[Interest expense (1 - Tax rate)]
Return on total assets =
Average total assets
=
$3,540 + [$600 (1 - 0.40)]

= 8.1%
$48,120
7. Calculation of the return on common stockholders equity:

Beginning balance, stockholders equity (a)..... $31,660
Ending balance, stockholders equity (b) ......... 34,880
Average stockholders equity [(a) + (b)]/2 ...... 33,270
Average preferred stock.................................
2,000
Average common stockholders equity ............ $31,270
Return on common =
stockholders' equity
Average common stockholders' equity
=
$3,540 - $120
= 10.9%
$31,270
8. Calculation of the book value per share:

Book value per share =
=
Total stockholders' equity - Preferred stock

Number of common shares outstanding
$34,880 - $2,000
= $41.10 per share
800 shares

912

1. Calculation of working capital:
Current assets .................
Current liabilities .............
Working capital ...............
$25,080
10,400
$14,680
2. Calculation of the current ratio:

Current assets
Current liabilities
$25,080
=
= 2.4
$10,400
Current ratio =
3. Calculation of the acid-test ratio:

Cash + Marketable securities
+ Current receivables
Acid-test ratio =
Current liabilities
$1,280 + $0 + $12,300
=
= 1.3
$10,400
4. Calculation of accounts receivable turnover:

Beginning balance, accounts receivable (a) .................
Ending balance, accounts receivable (b) .....................
Average accounts receivable balance [(a) + (b)]/2 ......
$ 9,100
12,300
$10,700
Sales on account
Accounts receivable =
turnover
Average accounts receivable balance
$79,000
=
= 7.4
$10,700
5. Calculation of the average collection period:

365 days
Accounts receivable turnover
365 days
=
= 49.3 days
7.4
Average collection period =

913

6. Calculation of inventory turnover:
Beginning balance, inventory (a) ................................
Ending balance, inventory (b) ....................................
Average inventory balance [(a) + (b)]/2 .....................
$8,200
9,700
$8,950
Cost of goods sold

Average inventory balance
$52,000
=
= 5.8
$8,950
Inventory turnover =
7. Calculation of the average sale period:

365 days
Inventory turnover
365 days
=
= 62.9 days
5.8
Average sale period =

914

1. Calculation of the times interest earned ratio:
Earnings before interest
expense
and income taxes
Times interest =
earned ratio
Interest expense
=
$6,500
= 10.8
$600
2. Calculation of the debt-to-equity ratio:

Total liabilities
Stockholders' equity
$15,400
=
= 0.4
$34,880
Debt-to-equity ratio =

915

1. The trend percentages are:
Year 5 Year 4 Year 3 Year 2 Year 1
Sales ................................ 125.0
120.0
115.0
110.0
100.0
Current assets:
Cash .............................. 60.0
Accounts receivable ........ 190.0
Inventory ....................... 125.0
Total current assets ........... 142.1
80.0
170.0
120.0
133.7
96.0
135.0
115.0
120.3
130.0
115.0
110.0
112.6
100.0
100.0
100.0
100.0
Current liabilities ............... 160.0
145.0
130.0
110.0
100.0
2. Sales:
The sales are increasing at a steady and consistent rate.
Assets:
The most noticeable thing about the assets is that the accounts receivable have been increasing at a rapid rate
far outstripping the increase in sales. This disproportionate increase in receivables is probably the chief cause of
the decrease in cash over the five-year period. The inventory seems to be growing at a well-balanced rate in comparison with sales.
Liabilities:
The current liabilities are growing more rapidly than the

total current assets. The reason is probably traceable to
the rapid buildup in receivables in that the company
doesnt have the cash needed to pay bills as they come
due.

916

1. Return on total assets:
Return on = Net income + [Interest expense (1 - Tax rate)]
total assets
=
$280,000 + [$60,000 (1 - 0.30)]

1/2 ($3,000,000 + $3,600,000)
$322,000
= 9.8% (rounded)
$3,300,000
2. Return on common stockholders equity:

Average stockholders equity:
($2,200,000 + $2,400,000)/2 ..................
Average preferred stock .............................
Average common stockholders equity (b) ...
$2,300,000
900,000
$1,400,000
Return on common = Net income - Preferred dividends

stockholders' equity Average common stockholders' equity
=
$280,000 - $72,000
=14.9% (rounded)
$1, 400,000
3. Leverage is positive because the return on common stockholders equity

(14.9%) is greater than the return on total assets (9.8%). This positive
leverage arises from the long-term debt, which has an after-tax interest
cost of only 8.4% [12% interest rate (1 0.30)], and the preferred
stock, which carries a dividend rate of only 8%. Both of these rates of
return are smaller than the return that the company is earning on its total assets; thus, the difference goes to the common stockholders.

917

1. Gross margin percentage:
Gross margin
$127,500
=
= 30.4% (rounded)
Sales
$420,000
2. Current ratio:
Current assets
$115,000
=
= 2.3
Current liabilities
$50,000
3. Acid-test ratio:
Quick assets
$41,500
=
= 0.83
Current liabilities
$50,000
4. Debt-to-equity ratio:
Total liabilities
$130,000
=
= 0.76 (rounded)
Total stockholders' equity
$170,000
5. Average collection period:

Accounts receivable turnover =
Sales on account
Average accounts receivable
$420,000
= 14
($25,000 + $35,000)/2
Average collection period =
365 days
Accounts receivable turnover
365 days
= 26.1 days (rounded)
14

918

6. Average sale period:
=
Average sale period =
Cost of goods sold

Average inventory
$292,500
= 4.5
($60,000 + $70,000)/2
365 days
= 81.1 days (rounded)
4.5
7. Times interest earned:

Earnings before interest
and income taxes
Times interest earned =
Interest expense
=
$38,000
= 4.75
$8,000
8. Book value per share:

$170,000
=
= $28.33 per share
Common shares outstanding
6,000 shares

919

1. Earnings per share:
Net income to common stock

$21,000
=
= $3.50 per share
Average number of common
6,000 shares
shares outstanding
2. Dividend payout ratio:
Dividends paid per share
$2.10
=
= 60%
Earnings per share
$3.50
3. Dividend yield ratio:

Dividends paid per share
$2.10
=
= 5%
$42.00
4. Price-earnings ratio:
$42.00
=
= 12
Earnings per share
$3.50

920

1. Return on total assets:
Return on = Net Income + Interest expense (1 - Tax rate)

total assets
=
$21,000 + $8,000 (1 - 0.30)
1/2 ($280,000 + $300,000)
$26,600
= 9.2% (rounded)
$290,000
2. Return on common stockholders equity:

Return on common =
stockholders' equity
Average common stockholders' equity
=
$21,000
1/2 ($161,600+$170,000)
$21,000
= 12.7% (rounded)
$165,800
3. Financial leverage was positive because the rate of return to the common stockholders (12.7%) was greater than the rate of return on total
assets (9.2%). This positive leverage is traceable in part to the companys current liabilities, which may have no interest cost, and in part, to
the bonds payable, which have an after-tax interest cost of only 7%.
10% interest rate (1 0.30) = 7%

921

1. Current assets
(Kr90,000 + Kr260,000 + Kr490,000 + Kr10,000) .......
Current liabilities (Kr850,000 2.5) ..............................
Working capital............................................................
Kr850,000
340,000
Kr510,000
2. Acid-test
Cash + Marketable securities + Accounts receivable
=
ratio
Current liabilities
=
Kr90,000 + Kr0 + Kr260,000

= 1.03 (rounded)
Kr340,000
3. a. Working capital would not be affected by a Kr40,000 payment on accounts payable:

Current assets (Kr850,000 Kr40,000) ..........
Current liabilities (Kr340,000 Kr40,000) .......
Working capital.............................................
Kr810,000
300,000
Kr510,000
b. The current ratio would increase if the company makes a Kr40,000

payment on accounts payable:
Current ratio =
Current assets
Current liabilities
Kr810,000
= 2.7
Kr300,000

922
Problem 16-11 (30 minutes)

1. a. Computation of working capital:
Current assets:
Cash ....................................... $ 50,000
Marketable securities ................
30,000
Accounts receivable, net ........... 200,000
Inventory ................................ 210,000
Prepaid expenses .....................
10,000
Total current assets (a) ............... 500,000
Current liabilities:
Accounts payable .....................
Notes due in one year ..............
Accrued liabilities .....................
Total current liabilities (b)............
150,000
30,000
20,000
200,000
Working capital (a) (b) ............. $300,000

b. Computation of the current ratio:
Current assets
$500,000
=
= 2.5
Current liabilities
$200,000
c. Computation of the acid-test ratio:
Cash + Marketable securities +

Accounts receivable
$280,000
=
= 1.4
Current liabilities
$200,000

923
Problem 16-11 (continued)

2.
(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
(i)
(j)
(k)
(l)
Transaction
Issued capital stock for cash .........

Sold inventory at a gain ................
Wrote off uncollectible accounts ....
Declared a cash dividend ..............
Paid accounts payable ..................
Borrowed on a short-term note .....
Sold inventory at a loss .................
Purchased inventory on account ....
Paid short-term notes ...................
Purchased equipment for cash ......
Sold marketable securities at a loss
Collected accounts receivable ........
The Effect on
Working Current Acid-Test
Capital
Ratio
Ratio
Increase
Increase
None
Decrease
None
None
Decrease
None
None
Decrease
Decrease
None
Increase
Increase
None
Decrease
Increase
Decrease
Decrease
Decrease
Increase
Decrease
Decrease
None
Increase
Increase
None
Decrease
Increase
Decrease
Increase
Decrease
Increase
Decrease
Decrease
None

924
This Year
Last Year
1. a. Current assets ......................................... $1,520,000 $1,090,000

Current liabilities......................................
800,000
430,000
Working capital........................................ $ 720,000 $ 660,000
b. Current assets (a) .................................... $1,520,000 $1,090,000
Current liabilities (b) ................................
$800,000
$430,000
Current ratio (a) (b) .............................
1.90
2.53
c. Quick assets (a) ......................................
Acid-test ratio (a) (b) ...........................
$550,000
$800,000
0.69
$468,000
$430,000
1.09
d. Sales on account (a) ................................ $5,000,000

Average receivables (b) ............................
$390,000
Accounts receivable turnover (a) (b) .....
12.8
$4,350,000
$275,000
15.8
Average collection period: 365 days

Accounts receivable turnover .................
28.5 days
23.1 days
e. Cost of goods sold (a) .............................. $3,875,000 $3,450,000

Average inventory (b) ..............................
$775,000
$550,000
Inventory turnover ratio(a) (b) ..............
5.0
6.3
Average sales period:
365 days Inventory turnover ratio .......
73.0 days
57.9 days
f. Total liabilities (a) .................................... $1,400,000 $1,030,000

Stockholders equity (b) ........................... $1,600,000 $1,430,000
Debt-to-equity ratio (a) (b) ...................
0.875
0.720
g. Net income before interest and taxes (a) ..
Interest expense (b) ................................
Times interest earned (a) (b) ................
$472,000
$72,000
6.6
$352,000
$72,000
4.9

925

2. a.
Sabin Electronics
Common-Size Balance Sheets
This Year Last Year
Current assets:
Cash ......................................................
2.3 %
Marketable securities ..............................
0.0
Accounts receivable, net ......................... 16.0
Inventory ............................................... 31.7
Prepaid expenses ...................................
0.7
Total current assets ................................... 50.7
Plant and equipment, net .......................... 49.3
Total assets .............................................. 100.0 %
Current liabilities ....................................... 26.7 %
Bonds payable, 12% ................................. 20.0
Total liabilities ........................................ 46.7
Stockholders equity:
Preferred stock, $25 par, 8% ...................
8.3
Common stock, $10 par .......................... 16.7
Retained earnings .................................. 28.3
Total stockholders equity .......................... 53.3
Total liabilities and equity .......................... 100.0 %
6.1 %
0.7
12.2
24.4
0.9
44.3
55.7
100.0 %
17.5 %
24.4
41.9
10.2
20.3
27.6
58.1
100.0 %

926

b.
Sabin Electronics
Common-Size Income Statements
This Year Last Year
Sales ..................................................... 100.0 %

Cost of goods sold .................................. 77.5
Gross margin ......................................... 22.5
Selling and administrative expenses ........ 13.1
Net operating income .............................
9.4
Interest expense ....................................
1.4
Net income before taxes .........................
8.0
Income taxes .........................................
2.4
Net income ............................................
5.6 %
100.0 %
79.3
20.7
12.6
8.1
1.7
6.4
1.9
4.5 %
3. The following points can be made from the analytical work in parts (1)
and (2) above:
a. The company has improved its profit margin from last year. This is attributable primarily to an increase in gross margin, which is offset
somewhat by a small increase in operating expenses. Overall, the
companys income statement looks very good.
b. The companys current position has deteriorated significantly since
last year. Both the current ratio and the acid-test ratio are well below
the industry average and are trending downward. At the present rate,
it will soon be impossible for the company to pay its bills as they
come due.
c. The drain on the cash account seems to be a result mostly of a large
buildup in accounts receivable and inventory. Notice that the average
age of the receivables has increased by five days since last year, and
now is 10 days over the industry average. Many of the companys
customers are not taking their discounts because the average collection period is 28 days and collections terms are 2/10, n/30. This suggests financial weakness on the part of these customers, or sales to
customers who are poor credit risks.

927

d. The inventory turned only five times this year as compared to over
six times last year. It takes nearly two weeks longer for the company
to turn its inventory than the average for the industry (73 days as
compared to 60 days for the industry). This suggests that inventory
stocks are higher than they need to be.
e. In the authors opinion, the loan should be approved only if the company gets its accounts receivable and inventory back under control. If
the accounts receivable collection period is reduced to about 20 days,
and if the inventory is pared down enough to reduce the turnover
time to about 60 days, enough funds could be released to substantially improve the companys cash position. Then a loan might not
even be needed.

928
This Year Last Year
1. a. Net income .......................................... $280,000 $196,000

Less preferred dividends .......................
20,000
20,000
Net income remaining for common (a) ... $260,000 $176,000
Average number of common shares (b) .
50,000
50,000
Earnings per share (a) (b) .................
$5.20
$3.52
b. Dividends per share (a) ........................

Market price per share (b) ....................
Dividend yield ratio (a) (b).................
$1.80
$40.00
4.5%
$1.50
$36.00
4.2%
c. Dividends per share (a) ........................

Earnings per share (b) ..........................
Payout ratio (a) (b) ...........................
$1.80
$5.20
34.6%
$1.50
$3.52
42.6%
d. Market price per share (a).....................

Earnings per share (b) ..........................
Price-earnings ratio (a) (b) ................
$40.00
$5.20
7.7
$36.00
$3.52
10.2
Investors regard Sabin Electronics less favorably than other companies in the industry. This is evidenced by the fact that they are willing
to pay only 7.7 times current earnings for a share of Sabins stock, as
compared to 12 times current earnings for other companies in the industry. If investors were willing to pay 12 times current earnings for
Sabins stock, it would be selling for about $62.40 per share (12
$5.20), rather than for only $40 per share.

929
This Year
Last Year
e. Total stockholders equity .......................... $1,600,000 $1,430,000

Less preferred stock .................................
250,000
250,000
Common stockholders equity (a) .............. $1,350,000 $1,180,000
(b) ........................................................
50,000
50,000
Book value per share (a) (b) ..................
$27.00
$23.60
The market value is above book value for both years. However, this
does not necessarily indicate that the stock is overpriced. Market value reflects investors perceptions of future earnings, whereas book
value is a result of already completed transactions.
2. a. Net income ........................................... $ 280,000 $ 196,000
Add after-tax cost of interest paid:
[$72,000 (1 0.30)] ........................
50,400
50,400
Total (a) ................................................ $ 330,400 $ 246,400
Average total assets (b) ......................... $2,730,000 $2,380,000
Return on total assets (a) (b) ..............
12.1%
10.4%
b. Net income ........................................... $ 80,000 $ 196,000

Less preferred dividends ........................
20,000
20,000
Net income remaining for common (a) .... $ 260,000 $ 176,000
Average total stockholders equity........... $1,515,000 $1,379,500
Less average preferred stock ..................
250,000
250,000
Average common equity (b) ................... $1,265,000 $1,129,500
Return on stockholders common equity
(a) (b) ............................................
20.6%
15.6%

930

c. Financial leverage is positive in both years because the return on
common equity is greater than the return on total assets. This positive financial leverage is due to three factors: the preferred stock,
which has a dividend rate of only 8%; the bonds, which have an after-tax interest cost of only 8.4% [12% interest rate (1 0.30) =
8.4%]; and the accounts payable, which may bear no interest cost.
3. We would recommend purchase. The stocks downside risk seems small
because it is now selling for only 7.7 times earnings to 12 times earnings
for other companies in the industry. In addition, its earnings are strong
and trending upward, and its return on common equity (20.6%) is extremely good. Its return on total assets (12.1%) compares well with
that of the industry. The risk, of course, is whether the company can get
its cash problem under control. Conceivably, the cash problem could
worsen, leading to an eventual reduction in profits through inability to
operate, a discontinuance of dividends, and a precipitous drop in the
market price of the companys stock. This does not seem likely, however,
because the company has borrowing capacity available, and can easily
control its cash problem through more careful management of accounts
receivable and inventory. The client must understand, of course, that
there is risk in the purchase of any stock; the risk seems well justified in
this case because the upward potential of the stock is great if the company gets its problems under control.

931
This Year
1. a. Net income .......................................... $

840,000 $
Add after-tax cost of interest:
$360,000 (1 0.30) .......................
252,000
$300,000 (1 0.30) .......................
Total (a) .............................................. $ 1,092,000 $
Last Year
504,000
210,000
714,000
Average total assets (b) ....................... $15,990,000 $13,920,000

Return on total assets (a) (b) ............
b. Net income ..........................................
Less preferred dividends.......................
Net income remaining for common (a) ..
6.8%
$
$
840,000
144,000
696,000
5.1%
$
$
504,000
144,000
360,000
Average total stockholders equity .........

Less average preferred stock ................
Average common equity (b) .................
$ 9,360,000
1,800,000
$ 7,560,000
$ 9,084,000
1,800,000
$ 7,284,000
Return on common stockholders equity (a) (b) .......................................
9.2%
4.9%
c. Leverage is positive for this year because the return on common equity (9.2%) is greater than the return on total assets (6.8%). For last
year, leverage is negative because the return on common equity
(4.9%) is less than the return on total assets (5.1%).

932

2. a. Net income remaining for common [see
above] (a)...........................................
Average number of common shares
outstanding (b) ...................................
Earnings per share (a) (b) ...................
This Year
Last Year
$696,000
$360,000
75,000
$9.28
75,000
$4.80
b. Dividends per share (a) ..........................

Market price per share (b) ......................
Dividend yield ratio (a) (b) ..................
$2.88
$72.00
4.0%
$1.44
$40.00
3.6%
c. Dividends per share (a) ..........................

Earnings per share (b)............................
Dividend payout ratio (a) (b) ...............
$2.88
$9.28
31.0%
$1.44
$4.80
30.0%
d. Market price per share (a) .......................

Earnings per share (b).............................
Price-earnings ratio (a) (b) ...................
$72.00
$9.28
7.8
$40.00
$4.80
8.3
Notice from the data given in the problem that the typical P/E ratio
for companies in Lydex Companys industry is 10. Since Lydex Company presently has a P/E ratio of only 7.8, so investors appear to regard it less well than they do other companies in the industry. That is,
investors are willing to pay only 7.8 times current earnings for a share
of Lydex Companys stock, as compared to 10 times current earnings
for a share of stock for the typical company in the industry.
e. Stockholders equity ............................... $9,600,000
Less preferred stock ............................... 1,800,000
Common stockholders equity (a) ............ $7,800,000
$9,120,000
1,800,000
$7,320,000

(b)......................................................
75,000
75,000
Book value per share (a) (b) ...............
$104.00
$97.60

933

Notice that market value of common stock is below its book value for
both years. This does not necessarily indicate that the stock is selling
at a bargain price. Market value reflects investors expectations concerning future earnings, whereas book value is a result of already
completed transactions and is geared to the past.
f.
This Year
Last Year
This Year
Last Year
Gross margin (a) .................................... $3,150,000

$2,580,000
Sales (b) ............................................... $15,750,000 $12,480,000
Gross margin percentage (a) (b) .........
20.0%
20.7%
3. a. Current assets ........................................

Current liabilities .....................................
Working capital .......................................
$7,800,000
3,900,000
$3,900,000
$5,940,000
2,760,000
$3,180,000
b. Current assets (a) ...................................

Current ratio (a) (b) .............................
$7,800,000
$3,900,000
2.0
$5,940,000
$2,760,000
2.15
c. Quick assets (a) ......................................

Acid-test ratio (a) (b) ...........................
$3,660,000
$3,900,000
0.94
$3,360,000
$2,760,000
1.22
d. Sales on account (a) ............................... $15,750,000 $12,480,000

Average receivables (b) ........................... $2,250,000 $1,680,000
Accounts receivable turnover (a) (b) .....
7.0
7.4
Average collection period,
365 days turnover .............................
52.1 days
49.3 days

934
This Year
Last Year
e. Cost of goods sold (a) ....................................................

$12,600,000 $9,900,000
Average inventory balance (b) ........................................
$3,150,000 $2,160,000
Inventory turnover ratio (a) (b) ...................................
4.0
4.6
Average sale period,
365 days Inventory turnover ratio .............................
91.3 days
79.3 days
f. Total liabilities (a) ...........................................................
$7,500,000 $5,760,000
Stockholders equity (b) ..................................................
$9,600,000 $9,120,000
Debt-to-equity ratio (a) (b) .........................................
0.78
0.63
Net income before interest and income
g. taxes (a) .....................................................................
$1,560,000 $1,020,000
Interest expense (b).......................................................
$360,000
$300,000
Times interest earned (a) (b) ......................................
4.3
3.4
4. Both net income and sales are up from last year. The return on total assets has improved from 5.1% to 6.8%, and the return on common equity is up from 4.9% to 9.2%. But this is the only bright spot. Virtually all
other ratios are below what is typical of the industry, and, more important, they are trending downward. The deterioration in the gross margin
percentage, while not large, is worrisome. Sales and inventories have
increased substantially. Ordinarily, this should result in an improvement
in the gross margin percentage due to fixed costs being spread over a
greater number of units. However, the gross margin percentage has declined.
Notice particularly that the average collection period has lengthened to
52 daysabout three weeks over the industry average. One wonders if
the increase in sales was obtained at least in part by extending credit to
high-risk customers. Notice also that the debt-to-equity ratio is rising rapidly. If the $3,000,000 loan is granted, the ratio will rise further to
1.09.
What the company probably needs is more equitynot more debt.
Therefore, the loan should not be approved. The company should be
encouraged to issue more common stock to provide a broader equity
base on which to operate.
935

1.
Lydex Company
Comparative Balance Sheets
Current assets:
Cash ...................................................
Marketable securities............................
Accounts receivable, net .......................
Inventory ............................................
Prepaid expenses .................................
Total current assets ................................
Plant and equipment, net ........................
Total assets ............................................
Current liabilities ....................................
Note payable, 10% .................................
Total liabilities ........................................
Preferred stock, 8%, $30 par value .......
Common stock, $80 par value...............
Retained earnings ................................
Total stockholders equity ........................
Total liabilities and equity ........................
This Year Last Year

5.6 %
8.5 %
0.0
2.0
15.8
12.1
22.8
16.1
1.4
1.2
45.6
39.9
54.4
60.1
100.0 % 100.0 %
22.8 %
21.1
43.9
18.5 %
20.2
38.7
10.5
12.1
35.1
40.3
10.5
8.9
56.1
61.3
100.0 % 100.0 %

936

2.
Lydex Company
Comparative Income Statements
This Year Last Year
Sales ..................................................... 100.0 %

Cost of goods sold ...................................
80.0
Gross margin ...........................................
20.0
Selling and administrative expenses ..........
10.1
Net operating income...............................
9.9
Interest expense......................................
2.3
Net income before taxes ..........................
7.6
Income taxes (30%) ................................
2.3
Net income..............................................
5.3%
100.0 %
79.3
20.7
12.5
8.2
2.4
5.8
1.7
4.0 %*
*Due to rounding, figures may not fully reconcile down a column.

3. The companys current position has declined substantially between the
two years. Cash this year represents only 5.6% of total assets, whereas
it represented 10.5% last year (cash + marketable securities). In addition, both accounts receivable and inventory are up from last year, which
helps to explain the decrease in the cash account. The company is building inventories, but not collecting from customers. (See Problem 16-14
for a ratio analysis of the current assets.) Apparently a part of the financing required to build inventories was supplied by short-term creditors, as evidenced by the increase in current liabilities.
Looking at the income statement, as noted in the solution to the preceding problem there has been a slight deterioration in the gross margin
percentage. Ordinarily, the increase in sales (and in inventories) should
have resulted in an increase in the gross margin percentage because
fixed manufacturing costs would be spread across more units. Note that
the selling and administrative expenses are down as a percentage of
salespossibly because many of them are likely to be fixed.

937
1.
Effect on
Ratio
Reason for Increase, Decrease, or No Effect
Decrease
Declaring a cash dividend will increase current liabilities,

but have no effect on current assets. Therefore, the current ratio will decrease.
2.
Increase
A sale of inventory on account will increase the quick assets (cash, accounts receivable, marketable securities) but
have no effect on the current liabilities. For this reason,
the acid-test ratio will increase. The same effect would result regardless of whether the inventory was sold at cost,
at a profit, or at a loss. That is, the acid-test ratio would
increase in all cases; the only difference would be the
amount of the increase.
3.
Increase
The interest rate on the bonds is only 8%. Since the companys assets earn at a rate of return of 10%, positive leverage would come into effect, increasing the return to
the common stockholders.
4.
Decrease
A decrease in net income would mean less income available to cover interest payments. Therefore, the timesinterest-earned ratio would decrease.
5.
Increase
Payment of a previously declared cash dividend will reduce both current assets and current liabilities by the
same amount. An equal reduction in both current assets
and current liabilities will always result in an increase in
the current ratio, so long as the current assets exceed the
current liabilities.
6.
No Effect
The dividend payout ratio is a function of the dividends

paid per share in relation to the earnings per share.
Changes in the market price of a stock have no effect on
this ratio.

938
7.
Effect on
Ratio
Increase
A write-off of inventory will reduce the inventory balance,

thereby increasing the turnover in relation to a given level
of sales.
8. Decrease
Sale of inventory at a profit will increase the assets of a

company. The increase in assets will be reflected in an increase in retained earnings, which is part of stockholders
equity. An increase in stockholders equity will result in a
decrease in the ratio of assets provided by creditors as
compared to assets provided by owners.
9. Decrease
Extended credit terms for customers means that customers

on the average will be taking longer to pay their bills. As a
result, the accounts receivable will turn over, or be collected, less frequently during a given year.
10. Decrease
A common stock dividend will result in a greater number of

shares outstanding, with no change in the underlying assets. The result will be a decrease in the book value per
share.
11. No Effect
Book value per share is dependent on historical costs of already completed transactions as reflected on a companys
balance sheet. It is not affected by current market prices
for the companys stock.
12. No Effect
Payments on account reduce cash and accounts payable by

equal amounts; thus, the net amount of working capital is
not affected.
13. Decrease
The stock dividend will increase the number of common

shares outstanding, thereby reducing the earnings per
share.

939
Effect on
Ratio
14. Decrease
Payments to creditors will reduce the total liabilities of a

company, thereby decreasing the ratio of total debt to total
equity.
15. Decrease
A purchase of inventory on account will increase current

liabilities, but will not increase the quick assets (cash, accounts receivable, marketable securities). Therefore, the
ratio of quick assets to current liabilities will decrease.
16. No Effect
Write-off of an uncollectible account against the Allowance

for Bad Debts will have no effect on total current assets.
For this reason, the current ratio will remain unchanged.
17. Increase
The price-earnings ratio is obtained by dividing the market

price per share by the earnings per share. If the earnings
per share remains unchanged, and the market price goes
up, then the price-earnings ratio will increase.
18. Decrease
The dividend yield ratio is obtained by dividing the dividend

per share by the market price per share. If the dividend per
share remains unchanged and the market price goes up,
then the yield will decrease.

940

a. It is becoming more difficult for the company to pay its bills as they
come due. Although the current ratio has improved over the three years,
the acid-test ratio is down. Also notice that the accounts receivable and
inventory are both turning more slowly, indicating that an increasing
portion of the current assets is being made up of these items, from
which bills cannot be paid.
b. Customers are paying their bills more slowly in Year 3 than in Year 1.
This is evidenced by the decline in accounts receivable turnover.
c. The total of accounts receivable is increasing. This is evidenced both by
a slowdown in turnover and in an increase in total sales.
d. The level of inventory undoubtedly is increasing. Notice that the inventory turnover is decreasing. Even if sales (and cost of goods sold) just
remained constant, this would be evidence of a larger average inventory
on hand. However, sales are not constant, but rather are increasing.
With sales increasing (and undoubtedly cost of goods sold also increasing), the average level of inventory must be increasing as well to service
the larger volume of sales.
e. The market price is going down. The dividends paid per share over the
three-year period are unchanged, but the dividend yield is going up.
Therefore, the market price per share of stock must be decreasing.
f. The amount of earnings per share is increasing. Again, the dividends
paid per share have remained constant. However, the dividend payout
ratio is decreasing. In order for the dividend payout ratio to be decreasing, the earnings per share must be increasing.
g. The price-earnings ratio is going down. If the market price of the stock
is going down [see Part (e) above], and the earnings per share are
going up [see Part (f) above], then the price-earnings ratio must be decreasing.
h. In Year 1 and in Year 2 there was negative leverage because in both
years the return on total assets exceeded the return on common equity.
In Year 3 there was positive leverage because in that year the return on
common equity exceeded the return on total assets employed.

941
Problem 16-18 (60 minutes or longer)

Pepper Industries
Income Statement
For the Year Ended March 31
Sales ................................................
Cost of goods sold ............................
Gross margin ....................................
Selling and administrative expenses ...
Net operating income ........................
Interest expense ...............................
Net income before taxes ...................
Income taxes (30%) .........................
Net income .......................................
$4,200,000
2,730,000
1,470,000
930,000
540,000
80,000
460,000
138,000
$ 322,000
Key to
Computation
(h)
(i)
(j)
(a)
(b)
(c)
(d)
Pepper Industries
Balance Sheet
March 31
Current assets:
Cash..............................................
Accounts receivable, net .................
Inventory.......................................
Total current assets...........................
Plant and equipment .........................
Total assets ......................................
Current liabilities ...............................
Bonds payable, 10% .........................
Total liabilities ...................................
Common stock, $5 par value ...........
Retained earnings ..........................
Total stockholders equity ..................
Total liabilities and equity ..................
70,000
330,000
480,000
880,000
1,520,000
$2,400,000
(f)
(e)
(g)
(g)
(q)
(p)
$ 320,000
800,000
1,120,000
(k)
(l)
700,000
580,000
1,280,000
$2,400,000
(m)
(o)
(n)
(p)

942

Computation of missing amounts:
a.
Times interest earned =
Earnings before interest and taxes

Interest expense
Earnings before interest and taxes

$80,000
= 6.75
Therefore, the earnings before interest and taxes for the year must be
$540,000.
b. Net income before taxes = $540,000 $80,000 = $460,000
c. Income taxes = $460,000 30% tax rate = $138,000
d. Net income = $460,000 $138,000 = $322,000
e.
Sales on account
Accounts receivable =
turnover
=
$4,200,000
= 14.0
Therefore, the average accounts receivable balance for the year must
have been $300,000. Since the beginning balance was $270,000, the
ending balance must have been $330,000.
f.
Acid-test ratio=
Cash + Marketable securities + Current receivables

Current liabilities

$320,000
= 1.25
943

Therefore, the total quick assets must be $400,000. Because there are
no marketable securities and the accounts receivable are $330,000, the
cash must be $70,000.
g.
Current ratio =
=
Current assets
Current liabilities
Current assets
$320,000
= 2.75
Therefore, the current assets must total $880,000. Because the quick
assets (cash and accounts receivable) total $400,000 of this amount, the
inventory must be $480,000.
h.
Cost of goods sold

Average inventory
Cost of goods sold

1/2 ($360,000 + $480,000)
Cost of goods sold

$420,000
= 6.5
Therefore, the cost of goods sold for the year must be $2,730,000.
i. Gross margin = $4,200,000 $2,730,000 = $1,470,000.
j.
Net operating income = Gross margin - Operating expenses

Operating expenses = Gross margin - Net operating income
= $1,470,000 - $540,000
= $930,000

944

k. The interest expense for the year was $80,000 and the interest rate was
10%, the bonds payable must total $800,000.
l. Total liabilities = $320,000 + $800,000 = $1,120,000
m.
Earnings per share =

Average number of common shares outstanding
$322,000
Average number of common shares outstanding
= $2.30
The stock is $5 par value per share, so the total common stock must be
$700,000.
n.
Debt-to-equity ratio =
Total liabilities
$1,120,000
= 0.875
Therefore, the total stockholders equity must be $1,280,000.

o.
Total stockholders' equity = Common stock + Retained earnings

Retained earnings = Total stockholders' equity - Common Stock
= $1,280,000 - $700,000 = $580,000

945

p.
Total assets = Liabilities + Stockholders' equity

= $1,120,000 + $1,280,000 = $2,400,000
This answer can also be obtained using the return on total assets:
Return on = Net income + [Interest expense (1 - Tax rate)]
total assets
=
$322,000 + [$80,000 (1 - 0.30)]

$378,000
= 18.0%
Therefore the average total assets must be $2,100,000. Since the total
assets at the beginning of the year were $1,800,000, the total assets at
the end of the year must have been $2,400,000 (which would also equal
the total of the liabilities and the stockholders equity).
q.
Total assets = Current assets + Plant and equipment

$2,400,000 = $880,000 + Plant and equipment
Plant and equipment = $2,400,000 - $880,000
= $1,520,000

946

1. The loan officer stipulated that the current ratio prior to obtaining the
loan must be higher than 2.0, the acid-test ratio must be higher than
1.0, and the interest on the loan must be less than four times net operating income. These ratios are computed below:
Current ratio =
=
Current assets
Current liabilities
$290,000
= 1.8 (rounded)
$164,000
Acid-test ratio =
=

Current liabilities
$70,000 + $0 + $50,000
= 0.7 (rounded)
$164,000
Net operating income

$20,000
=
= 5.0
Interest on the loan
$80,000 0.10 (6/12)
The company would fail to qualify for the loan because both its current
ratio and its acid-test ratio are too low.

947

2. By reclassifying the $45 thousand net book value of the old machine as
inventory, the current ratio would improve, but the acid-test ratio would
be unaffected. Inventory is considered a current asset for purposes of
computing the current ratio, but is not included in the numerator when
computing the acid-test ratio.
Current ratio =
=
Current assets
Current liabilities
$290,000 + $45,000
= 2.0 (rounded)
$164,000
Acid-test ratio =
=

Current liabilities
$70,000 + $0 + $50,000
= 0.7 (rounded)
$164,000
Even if this tactic had succeeded in qualifying the company for the loan,
we strongly advise against it. Inventories are assets the company has
acquired to sell to customers in the normal course of business. Used
production equipment is not inventoryeven if there is a clear intention
to sell it in the near future. The loan officer would not expect used
equipment to be included in inventories; doing so would be intentionally
misleading.

948

Nevertheless, the old machine is an asset that could be turned into
cash. If this were done, the company would immediately qualify for the
loan because the $45 thousand in cash would be included in the numerator in both the current ratio and in the acid-test ratio.
Current ratio =
=
Current assets
Current liabilities
$290,000 + $45,000
= 2.0 (rounded)
$164,000
Acid-test ratio =
=

Current liabilities
$70,000 + $0 + $50,000 + $45,000
= 1.0 (rounded)
$164,000
However, other options may be available. The old machine is being used
to relieve bottlenecks in the plastic injection molding process and it
would be desirable to keep this standby capacity. We would advise Russ
to fully and honestly explain the situation to the loan officer. The loan
officer might insist that the machine be sold before any loan is approved, but she might instead grant a waiver of the current ratio and
acid-test ratio requirements on the basis that they could be satisfied by
selling the old machine. Or she may approve the loan on the condition
that the machine is pledged as collateral. In that case, Russ would only
have to sell the machine if he would otherwise be unable to pay back
the loan.

949
Research and Application 16-20

1. The 5-year horizontal analysis in dollar and percentage form is summarized below (dollar amounts
are in millions):
Sales ..................................................
Earnings from continuing operations.....
Sales ..................................................
Earnings from continuing operations.....
2004
$45,682
$1,885
2004
155%
196%
2003
2002
$40,928
$1,619
$36,519
$1,376
2003
2002
139%
168%
124%
143%
2001
2000
2001
2000
$32,602 $29,462
$1,101
$962
111%
114%
100%
100%
The data reveal that Target has increased sales by 55% over the last five years. More importantly,
the sales growth has been profitable; Targets earnings from continuing operations have increased
96% over the same time period. Also, Target has consistently improved its performance. There were
no unexpected drops in sales or earnings. This type of consistency is valued by investors.

950
Research and Application 16-20 (continued)

2. The common size comparative balance sheet is shown below (dollar amounts are in millions):
Target Corporation
Common-Size Comparative Balance Sheet
January 29, 2005 and January 31, 2004
Assets
Current assets:
Cash and cash equivalents...........................
Accounts receivable, net ..............................
Inventory ...................................................
Other current assets....................................
Current assetsdiscontinued .......................
Total current assets ....................................
Property and equipment:
Land ..........................................................
Buildings and improvements ........................
Fixtures and equipment ...............................
Construction-in-progress .............................
Accumulated depreciation ............................
Property and equipment, net ..........................
Other non-current assets ...............................
Non-current assetsdiscontinued ...................
Total assets...................................................
2004
2003
Common-Size
Percentages
2004
2003
$ 2,245
5,069
5,384
1,224
0
13,922
$ 708
4,621
4,531
1,000
2,092
12,952
6.9%
15.7%
16.7%
3.8%
0%
43.1%
2.2%
14.7%
14.4%
3.2%
6.7%
41.2%
3,804
12,518
4,988
962
( 5,412)
16,860
1,511
0
$32,293
3,312
11,022
4,577
969
( 4,727)
15,153
1,377
1,934
$31,416
11.8%
38.8%
15.4%
3.0%
( 16.8%)
52.2%
4.7%
0.0%
100.0%
10.5%
35.0%
14.6%
3.1%
( 15.0%)
48.2%
4.4%
6.2%
100.0%

951
Liabilities and shareholders investment

Current liabilities:
Accounts payable ........................................
Accrued liabilities ........................................
Income taxes payable .................................
Current portion of long-term debt ................
Current liabilitiesdiscontinued ...................
Total current liabilities....................................
Long-term debt ...........................................
Deferred income taxes ................................
Other noncurrent liabilities...........................
Noncurrent liabilitiesdiscontinued ..............
Total liabilities ...............................................
Shareholders investment:
Common stock ............................................
Additional paid-in-capital .............................
Retained earnings .......................................
Accumulated other income ..........................
Total shareholders investment .......................
Total liabilities and shareholders investment ...
2004
2003
Common-Size
Percentages
2004
2003
$ 5,779
1,633
304
504
0
8,220
9,034
973
1,037
0
19,264
$ 4,956
1,288
382
863
825
8,314
10,155
632
917
266
20,284
17.9%
5.1%
0.8%
1.6%
0.0%
25.5%
28.0%
3.0%
3.2%
0.0%
59.7%
15.8%
4.1%
1.2%
2.8%
2.6%
26.5%
32.3%
2.0%
2.9%
0.9%
64.6%
74
1,810
11,148
(
3)
13,029
$32,293
76
1,530
9,523
3
11,132
$31,416
0.2%
5.6%
34.5%
( 0.0%)
40.3%
100.0%
0.2%
4.9%
30.3%
0.0%
35.4%
100.0%

952

3. Target uses sales for its vertical analysis of profitability. This can be confirmed by verifying how Target computed its gross margin rates (31.2%
for 2004 and 30.6% for 2003) and selling, general and administrative
(SG&A) expense rates (21.4% for 2004 and 21.2% for 2003) that are
shown on pages 17-18 of the annual report. The computations are
shown below:
2004
2003
Sales ..............................
Cost of sales ...................
Gross margin ..................
$45,682
31,445
$14,237
$40,928
28,389
$12,539
Gross margin ..................

Sales ..............................
Gross margin rate ...........
$14,237
$45,682
31.2%
$12,539
$40,928
30.6%
SG&A expense ................

Sales ..............................
SG&A rate.......................
$9,797
$45,682
21.4%
$8,657
$40,928
21.2%
Target uses sales instead of total revenues as a base because total revenues include net credit card revenues. Page 17 of the annual report
says Net credit card revenues represent income derived from finance
charges, late fees and other revenues from use of our Target Visa and
proprietary Target Card. These sources of revenue do not relate to the
companys primary business operations. Computing common-size income statement percentages using total revenue as the baseline could
potentially distort conclusions about operational performance.
4. The calculations for these ratios are shown below (all numbers except
per share information and percentages are in millions):
Earnings per share:
Earnings from continuing operations.............................

Average number of common shares outstanding ...........
Earnings per sharecontinuing operations....................
2004
$1,885
903.8
$2.09
*Target did not have any preferred stock outstanding

953
Price-earnings ratio:
Market price per share ................................................

Earnings per sharecontinuing operations ...................
Price-earnings ratio .....................................................
Dividend payout ratio:
Dividends per share ....................................................

Earnings per sharecontinuing operations ...................
Dividend payout ratio ..................................................
Dividend yield ratio:
Dividends per share ....................................................

Market price per share ................................................
Dividend yield ratio .....................................................
Return on total assets:
Earnings from continuing operations ...........................

Add back interest expense: $570 (1 0.378*) ..........
Total (a) .....................................................................
Average total assets ($31,416 + $32,293)/2 (b) ...........
Return on total assets (a) (b) ...................................
2004
$49.49
$2.09
23.68
$0.31
$2.09
14.8%
$0.31
$49.49
0.6%
$1,885
355
$2,240
$31,855
7.0%
*Provision for income taxes ($1,146) divided by earnings before income taxes ($3,031) = 37.8%.
Return on common stockholders equity:
Earnings from continuing operations ............................

Average common stockholders equity
($13,029 + $11,132)/2 .............................................
Return on common stockholders equity .......................
Book value per share:
Common stockholders equity ......................................

Number of common shares outstanding .......................
Book value per share ...................................................
$1,885
$12,081
15.6%
$13,029
890.6
$14.63

954

5. The calculations for these ratios are shown below (all dollar figures are
in millions):
Working capital:
Current assets ..........................................

Current liabilities ......................................
Working capital ........................................
Current ratio:
Current assets ..........................................

Current ratio ............................................
Acid-test ratio:
Quick assets ($2,245 + $5,069)..............

Acid-test ratio ..........................................
Inventory turnover:
Cost of sales ............................................

Average inventory ($5,384 + $4,531)/2 .....
Inventory turnover ...................................
Average sales period:
Number of days in a year..........................

Inventory turnover ...................................
Average sale period in days ......................
2004
$13,922
8,220
$ 5,702
$13,922
$8,220
1.69
$7,314
$8,220
0.89
$31,445
$4,958
6.34
365 days
6.34
57.6 days
Note to instructors: The accounts receivable turnover and average collection period are not calculated because it is impossible to determine
the portion of Targets total sales that are credit sales.

955

6. The calculations for these ratios are shown below (all dollar figures are
in millions):
Times interest earned ratio:
Earnings before interest expense and income taxes ..

Interest expense ....................................................
Times interest earned .............................................
Debt-to-equity ratio:
Total liabilities ........................................................

Stockholders equity ...............................................
Debt-to-equity ratio ................................................
2004
$3,601
$570
6.3
$19,264
$13,029
1.48
7. Target has better liquidity than Wal-Mart as measured by the current

and acid-test ratios. Target turns over its inventory less frequently than
Wal-Mart which is renowned for its supply chain management practices.
While Wal-Marts times interest earned ratio is much higher than Targets, both companies provide sufficient comfort to their long-term creditors in this regard. The companies have comparable debt-to-equity ratios. Targets return on total assets is lower than Wal-Marts; however,
Targets slightly higher price-earnings ratio suggests that investors believe Target has modestly stronger earnings growth prospects than WalMart.

956

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16-5 The dividend yield is the dividend per

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Managerial Accounting, 13th Edition

inventory, or the inventory may contain large

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Exercise 16-1 (15 minutes)

This Year Last Year

2. The companys major problem seems to be the increase in cost of goods

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Managerial Accounting, 13th Edition

Exercise 16-2 (30 minutes)

Gross margin percentage =

2. Calculation of the earnings per share:

Earnings per share =

3. Calculation of the price-earnings ratio:

4. Calculation of the dividend payout ratio:

Dividend payout ratio =

5. Calculation of the dividend yield ratio:

Dividend yield ratio =

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Exercise 16-2 (continued)

$3,540 + [$600 (1 - 0.40)]

7. Calculation of the return on common stockholders equity:

8. Calculation of the book value per share:

Total stockholders' equity - Preferred stock

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Managerial Accounting, 13th Edition

Exercise 16-3 (30 minutes)

2. Calculation of the current ratio:

3. Calculation of the acid-test ratio:

4. Calculation of accounts receivable turnover:

5. Calculation of the average collection period:

Average collection period =

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Exercise 16-3 (continued)

Cost of goods sold

7. Calculation of the average sale period:

Average sale period =

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Managerial Accounting, 13th Edition

Exercise 16-4 (15 minutes)

2. Calculation of the debt-to-equity ratio:

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Exercise 16-5 (15 minutes)

Year 5 Year 4 Year 3 Year 2 Year 1

Sales ................................ 125.0

Current liabilities ............... 160.0

The sales are increasing at a steady and consistent rate.

The current liabilities are growing more rapidly than the

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Managerial Accounting, 13th Edition

Exercise 16-6 (20 minutes)

$280,000 + [$60,000 (1 - 0.30)]

2. Return on common stockholders equity:

Return on common = Net income - Preferred dividends

3. Leverage is positive because the return on common stockholders equity

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Exercise 16-7 (30 minutes)

5. Average collection period:

Average collection period =

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Managerial Accounting, 13th Edition