Chapter 2
Suggested Questions and Answers
Q1) Penguin Pucks, Inc., has a current assets of $4,800, net fixed assets of $27,500, current
liabilities of $4,200, and long-term debt of $10,500. What is the value of shareholders’ equity
account for this firm?
To find owners’ equity, we must construct a balance sheet as follows:
Balance Sheet
CA
NFA
$ 4,800
27,500
CL
$ 4,200
LTD
10,500
OE
TA
$32,300
??
TL & OE $32,300
We know that total liabilities and owners’ equity (TL & OE) must equal total assets of
$32,300. We also know that TL & OE is equal to current liabilities plus long-term debt
plus owners’ equity, so owners’ equity is:
OE = $32,300 – 10,500 – 4,200 = $17,600
NWC = CA – CL = $4,800 – 4,200 = $600
Q2) Billy’s Exterminators, Inc., has a sales of $734,000, costs of $315,000, depereciation
expense of $48,000, interest expense of $35,000, and a tax rate of 35%. What is the net income
for this firm?
The income statement for the company is:
Income Statement
Sales
$734,000
Costs
315,000
Depreciation
EBIT
Interest
EBT
48,000
$371,000
35,000
$336,000
Taxes (35%)
117,600
Net income
$218,400
Q8) Chevelle, Inc., has sales of $39,500, costs of $18,400, depreciation expense of $1,900, and
interest expense pf $1,400. If the tax rate is 35%, what is the operating cash flows, or OCF?
To calculate OCF, we first need the income statement:
Income Statement
Sales
$39,500
Costs
18,400
Depreciation
EBIT
Interest
Taxable income
Taxes (35%)
Net income
1,900
$19,200
1,400
$17,800
6,230
$11,570
OCF = EBIT + Depreciation – Taxes = $19,200 + 1,900 – 6,230 = $14,870
Q10) The 2010 balance sheet of Greystone, Inc., showed current assets of $3,120 and current
liabilities of $1,570. The 2011 balance sheet showed current assets of $3,460 and current
liabilities of $1,980. What was the company’s 2011 change in net working capital, or NWC?
Change in NWC = NWCend – NWCbeg
Change in NWC = (CAend – CLend) – (CAbeg – CLbeg)
Change in NWC = ($3,460 – 1,980) – ($3,120 – 1,570)
Change in NWC = $1,480 – 1,550 = –$70
Q21) Zigs Industries had the following operating results for 2011: sales= $27,360; cost of goods
sold= $19,260; depreciation expense= $4,860; interest expense= $2,190; dividends paid= $1,560.
At the beginning of the year, net fixed assets were $16,380, current assets were $5,760, and
current liabilities were $3,240. At the end of the year, net fixed assets were $20,160, current
assets were $7,116, and the current liabilities were $3,780. The tax rate for 2011 was 34%
a) what is the net income for 2011?
b) What is the operating cash flow for 2011?
c) What is the cash flow from assets for 2011? Is this possible? Explain.
a.
Income Statement
Sales
$27,360
Cost of goods sold
19,260
Depreciation
EBIT
4,860
$ 3,240
Interest
Taxable income
2,190
$ 1,050
Taxes (34%)
Net income
357
$
693
b. OCF = EBIT + Depreciation – Taxes
= $3,240 + 4,860 – 357 = $7,743
c. Change in NWC = NWCend – NWCbeg
= (CAend – CLend) – (CAbeg – CLbeg)
= ($7,116 – 3,780) – ($5,760 – 3,240)
= $3,336 – 2,520 = $816
Net capital spending = NFAend – NFAbeg + Depreciation
= $20,160 – 16,380 + 4,860 = $8,640
CFA
= OCF – Change in NWC – Net capital spending
= $7,743 – 816 – 8,640 = –$1,713
The cash flow from assets can be positive or negative, since it represents whether the
firm raised funds or distributed funds on a net basis. In this problem, even though net
income and OCF are positive, the firm invested heavily in both fixed assets and net
working capital; it had to raise a net $1,713 in funds from its stockholders and
creditors to make these investments.
Chapter 3
Suggested Questions and Answers
Q1) SDJ, Inc., has net working capital of $2,710, current liabilities of $3,950, and inventory of
$3,420. What is the current ratio? What is the quick ratio?
Using the formula for NWC, we get:
NWC = CA – CL
CA = CL + NWC = $2,710 + 3,950 = $6,660
So, the current ratio is:
Current ratio = CA / CL = $6,660/$3,950 = 1.69 times
And the quick ratio is:
Quick ratio = (CA – Inventory) / CL = ($6,660 – 3,420) / $3,950 = 0.82 times
Q2) Diamond Eyes, Inc., has sales of $18 million, total assets of $15.6 million, and total debt of
$6.3 million. If the profit margin is 8%, what is net income? What is ROA? What is ROE?
We need to find net income first. So:
Profit margin = Net income / Sales
Net income = Sales(Profit margin)
Net income = ($18,000,000)(0.08) = $1,440,000
ROA = Net income / TA = $1,440,000 / $15,600,000 = .0923, or 9.23%
To find ROE, we need to find total equity. Since TL & OE equals TA:
TA = TD + TE
TE = TA – TD
TE = $15,600,000 – 6,300,000 = $9,300,000
ROE = Net income / TE = 1,440,000 / $9,300,000 = .1548, or 15.48%
Q7) If Roten Rooters, Inc., has an equity multiplier of 1.45, total asset turnover of 1.80, and a
profit margin of 5.5%, what is its ROE?
ROE = (PM)(TAT)(EM)
ROE = (.055)(1.80)(1.45) = .1436, or 14.36%
Q22) Firm A and B have debt-total asset ratios of 45% and 35% and returns on total assets of 9%
and 12%, respectively. Which firm has a greater return on equity?
The solution requires substituting two ratios into a third ratio. Rearranging D/TA:
Firm A
Firm B
D / TA = .45
D / TA = .35
(TA – E) / TA = .45
(TA – E) / TA = .35
(TA / TA) – (E / TA) = .45
(TA / TA) – (E / TA) = .35
1 – (E / TA) = .45
1 – (E / TA) = .35
E / TA = .55
E / TA = .65
E = .55(TA)
E = .65 (TA)
Rearranging ROA, we find:
NI / TA = .09
NI / TA = .12
NI = .09(TA)
NI = .12(TA)
Since ROE = NI / E, we can substitute the above equations into the ROE formula, which
yields:
ROE = .09(TA) / .55(TA) = .09 / .55 = 16.36% ROE = .12(TA) / .65 (TA) = .12 / .65 =
18.46%