Financial and Managerial Accounting
Final Examination, Form A
Fall 2006
1
Required: Place your name and form letter in the top right corner of your answer sheet. Number your paper from 1 to 30
down the left column.
MULTIPLE CHOICE (1 point each): Select the best response from among those listed.
1. Which of the four basic financial statements would contain a line item for revenues?
a. Balance sheet
b. Income statement c. Statement of equity d. Statement of cash flows
2. All of the following are normally included in current assets, EXCEPT:
a. Inventories
b. Accounts Receivable c. Prepaid Expenses
3. Another name for “Statement of Operations” is the:
a. Income statement
b. Statement of Financial Position
d. Statement of Operations e. Asset Statement
4. A current liability is one that
a. Is patient
b. Requires payment over coming year
d. Can be paid
e. Is convertible into shares of stock
5. Which of the following is an investing activity?
a. Issue common stock
b. Pay a dividend
d. Build production plan
e. Allowance for Bad Debts
d. Cash
e. Retained Earnings
c. Cash Flow Statement
c. Must be paid within the next few weeks
c. Depreciation of Equipment
6. An asset is impaired and must be written down in the financial report, when the net book value is:
a. lesser than the sum of discounted expected cash flows.
b. lesser than the sum of undiscounted expected cash flows.
c. greater than the sum of undiscounted expected cash flows.
d. greater than the sum of discounted expected cash flows.
7. Receivables turnover is calculated as:
a. Cost of Goods Sold divided by average receivables
b. Receivables divided by average sales
c. Sales minus receivables
d. Sales divided by average receivables
e. Sales divided by Cost of Goods Sold
8. The most common methods of depreciation for the financial report and the income tax return are:
Financial Report
Income Tax Return
a. Straight Line
Straight Line
b. Declining Balance
Modified Accelerated Cost Recover System
c. Straight Line
Sum of Years Digits
d. Straight Line
Modified Accelerated Cost Recover System
e. Sum of Years Digits
Straight Line
9. At what percentage of a company owned is it presumed that sufficient influence is present to require that the
investment be consolidated into the companies financial reports?
a. 0 – 20% b. 20% - 50% c. 50% - 75% d. 50% or greater
10. The requirements for revenue to be recognized include all of the following except:
a. Service performed or product delivered.
b. The title to the goods transferred.
c. The collectibility of the receivable can be estimated.
d. The account has been collected.
11. Which of the following costs are most difficult to trace to specific units of production or other cost objectives?
a. Direct labor costs
c. Production overhead costs
b. Prime costs
d. Raw materials costs
12. In applying the high-low method to estimating fixed and variable costs:
a. the highest and lowest cost are selected
d. the costs are listed in alphabetic order
b. the costs are listed from largest to smallest
e. the highest and lowest volumes are selected
c. the emotional states of the costs must be carefully assessed
13. The difference between absorption and variable costing is primarily:
a. that fixed costs are included in inventory in absorption cost and they are not for variable costing
b. that variable costing includes variable selling costs in inventory
c. that absorption costing includes costs of administration in inventory
d. variable costing includes only opportunity costs in inventory
e. that there is no inventory under variable costing, where absorption costing results in less inventory
Financial and Managerial Accounting
Final Examination, Form A
Fall 2006
2
14. Which best describes par value for a stock?
a. The value at which stock shares were issued
b. The current market value of the stock
c. Expected value of a stock.
d. An arbitrary amount set by the company for each share of stock
15. Which of the following is NOT a common use of a variable interest entity as a financing tool?
a. Raising equity
c. Financing of construction projects
b. Securitization of assets
d. Project financing
16. Comparing least-squares regression to high-low estimation:
a. Least-squares regression makes fuller use of the data
b. Least-squares regression requires fewer calculations
c. Least-squares regression requires more analyses than the most-circular progression method
d. Least-squares regression better predicts costs outside the range of past observations
17. Operating leverage is computed as:
a. A extended portion of the surgeon’s strength
b. Fixed costs divided by income before taxes
c. Income before taxes divided by total debt
d. Operating income divided by total debt
e. Contribution margin divided by income before taxes
18. When operating at capacity, a company loses income earned from regular customers by accepting a special order.
The loss of income is an example of which of the following?
a. An opportunity cost
c. An unavoidable cost
b. A revenue cost
d. A sunk cost
19. Which of the following activities in a physician's office is value-added?
a. Physician’s assistant makes appointment with patient over the telephone.
b. Patient checks in at physician’s office.
c. Patient is placed in one of several examining rooms.
d. Physician provides treatment.
20. The method of accounting for inventory that assigns all manufacturing costs to inventory is sometimes referred to as:
a. The weighted average cost method.
c. Absorption costing.
b. Prime costing
d. FIFO.
21. The cost of goods sold calculated using variable costing as opposed to absorption costing will generally be:
a. the same. b. similar. c. smaller. d. larger.
22. When monthly production volume is constant and sales volume is less than production, net income determined with
variable costing procedures will:
a.
always be greater than net income determined using absorption costing.
b.
always be less than net income determined using absorption costing.
c.
be equal to net income determined using absorption costing.
d.
be equal to contribution margin per unit times units sold.
23. The law prohibiting sellers from charging different prices to different purchasers is known as:
a.
the Robinson-Patman Act.
c.
Rule 10b-5 of the Securities and Exchange Act.
b.
the Sherman Anti-trust Act.
d.
the Rockefeller Bill.
24. The Sherman Anti-trust Act prohibits:
a.
price discrimination.
c.
b.
cost-based pricing.
d.
price fixing.
target costing.
25. Which of the following capital budgeting techniques provides the decision maker with answers expressed in dollars?
a.
Accounting rate of return
c.
Internal rate of return
b.
Net present value
d.
Payback method
Financial and Managerial Accounting
Final Examination, Form A
Fall 2006
3
26. The ________________ is the discount rate that equates the present value of a project's cash inflows with the present
value of the project's outflows.
a.
Cost of capital
c.
Internal rate of return
b.
Present value index
d.
Time adjusted accounting rate of return
27. Which of the following budget levels tends to result in the maximum motivation:
a. Challenging, but attainable b. Easy to achieve
c. Very difficult to achieve
d. Moderately easy
28. When management directs attention only to those activities not proceeding according to plan, they are engaging in:
a.
Activity-based management
c.
Organization-based management
b.
Management by exception
d.
Just-in-time management
29. In a segment report for sales territories, the contribution margin less direct territory fixed costs would be known as:
a. Segment margin.
c.
Product margin.
b. Territory margin.
d.
Fixed costs.
30. The term "division margin" is used to describe the:
a. Excess of manufacturing margin over all variable expenses.
b. Sum of division cost of goods sold and net income.
c. Amount a given division contributes toward covering common corporate expenses.
d. Excess of division sales over its variable manufacturing expenses.
EXERCISES: PLEASE SHOW YOUR CALCULATIONS ON YOUR WORKSHEET.
Exercise A (4 points)
The following items and amounts are taken from the 2006 financial statements of Motzek, Inc.
Equipment…………………..
31,000
Common stock………
5,900
Cost of goods sold……………. 26,000
Depreciation expense
5,700
Utilities expense…………….
2,100
Retained Earnings (Beg.)……
14,000
Accumulated depreciation..
8,600
Dividends……………
7,600
Accounts payable……………
10,200
Service revenue………
59,000
Cash…………………………
4,300
Repair expense………
2,500
Accounts receivable……….. . 7,500
Insurance expense………
1,200
Prepaid insurance…………...
$ 2,800
Salaries Expense……..
$ 10,000
Using this information, compute the following:
a. Gross margin
b. Operating Income before taxes
c. Return on sales
d. Total assets
Exercise B (4 points)
The Little Cinema purchased a new projector costing $30,000 on January 1, 2005. Because of changing
technologies, the projector is estimated to last 4 years after which it will be salvaged at an amount estimated
to be $5,000. Compute the depreciation expense for 2006 using:
a. The straight-line method
b. Double-declining-balance method
Exercise C (4 points)
The M. McCucheon Co. uses aging of accounts approach to estimate the uncollectible accounts receivable. Based upon
recent collection history, it developed the following chart indicated percentages on uncollectible accounts receivable:
0-30 days
5%
31-90 days
12%
91-120 days
15%
more than 120 days
30%
At December 31, 2006, McCucheon’s accountant prepared the following aging of its accounts receivable balance:
0-30 days
$3,000,000
31-90 days
2,000,000
91-120 days
1,000,000
more than 120 days
1,500,000
Total
$7,500,000
REQUIRED: What should be the amount reported for net accounts receivable on the balance sheet as of December 31,
2006?
Financial and Managerial Accounting
Final Examination, Form A
Fall 2006
4
Exercise D (6 points) The following information pertains to the C. East, Inc. projected income statement for the month of
December 2006 when 80,000 units were sold:
Sales
$600,000
Variable costs
320,000
Contribution Margin
Fixed Costs
$280,000
290,000
Net loss
$ (10,000)
The company has the capacity to produce 100,000 units of service per month. Mr. East requires profits before tax of
$50,000 per month.
REQUIRED:
a. Determine the breakeven point in units and the breakeven utilization as a % of capacity.
b. Determine the required volume and the required utilization as a % of capacity.
c. The purchase of automated equipment will increase fixed costs by $100,000 per month and reduce labor costs by $2
per unit. Determine the impact of this on required volume.
d. Independent of (c.), if the price were increased by $3 per unit, the volume is expected to fall by about 10,000 units.
Compute the impact of this price change on the projected net loss for December 2006.
Exercise E (4 points) Assume that the following predictions were made for 2006 for LVU PC, a legal practice
specializing in the litigation defense of commercial and industrial injury cases and related law:
Total litigation overhead for the year….……… $24,000,000
Total case hours projected for the year………
240,000
Actual results for the Month of December 2006:
Litigation overhead costs incurred for month..
$ 2,200,100
Hours worked on cases for month……………
21,000
Required:
a. Determine the 2006 predetermined litigation overhead rate per case hour.
b. Determine the amount of litigation overhead applied to cases worked during December 2006.
c. As of December 1, 2006, actual overhead was underapplied by $1,234,000. Determine the cumulative amount of
overapplied or underapplied overhead at the end of December.
Exercise F (4 points) Use the following information to prepare the shareholders’ equity section of the balance sheet for
Buster’s, Inc.:
a. Common Stock - $1 par value: 500,000 shares authorized, 400,000 shares issued as of December 31, 2006
b. Retained Earnings, December 31, 2006, $250,000
c. Treasury Stock – Buster repurchased 10,000 shares at $20 per share
d. Total Shareholders’ Equity as of December 31, 2006 is $1,000,000
Required:
a. What is the amount of paid-in capital?
b. What was the average price at which shares of common stock were issued?
Exercise G (4 points) The Justin Co. is evaluating a proposal for a new product that requires an investment of $100,000
and promises annual income after tax of $25,000 for each of five years. They are using the straight-line depreciation
method with a zero salvage value for both the financial report and for estimated taxes. Their tax rate is 30%. The
company requires a payback in 3 years and at least a 16% discounted rate of return. The following present value factors
may be useful:
12%
14%
16%
18%
Annuity for 5 years
3.605 3.433 3.274
3.127
Amount in 5 years
.567
.519
.476
.437
REQUIRED:
a. Compute the promised annual cash flows.
b. Compute the payback period in years.
c. Compute the net present value of the project.
Exercise H (4 points) The WestTex Division of XXYX International is located in Amarillo Texas. XXYX requires a 20%
return on investment, has a 15% cost of capital, and has a 30 per cent tax rate. Selected information for WestTex is as
follows:
Revenues
$10,000,000
Income before taxes
$2,000,000
Assets of the division
$5,000,000
Liabilities of the division
$1,000,000
REQUIRED:
a.
Net income of the division
c. Return on investment
b.
Residual income
d. Economic value added residual income
Financial and Managerial Accounting
Final Examination, Form A
Fall 2006
5
Short Essays (4 points each).
A. What was the basic fraud that Bernie Ebbers committed in the World Com case?
B. One fundamental internal control is “separation of duties”. Describe this control and why it is important for preventing
fraud in financial reports.
C. According to the instructor, what activities must managers do in order to justify their position and keep their job?
D. In the “Day Care in Public Housing” case, the break-even volume was about 90% of capacity. What was the
significance of this finding for assessing the subsequent results?
E. How do each of the following cost management options attempt to make a company more efficient? (1) Variety
management (focus program), (2) Activity-based management, (3) Target product design, and (4) Cellular production.
F. The PSC Co. has total projected healthcare related costs for 2006 of about $600 million for its 40,000 USA employees
and retirees. The net income of the company has ranged from $223 million for 2001 to a projected loss of $53 million for
2006. While employees (and retirees) have increased by about 25% over the past five years, the healthcare costs have
increased by 108%. List 2 options that PSC Co. should consider pursuing to help better manage or reduce healthcare
costs over the next 5 years. List a strength and a weakness for each option.
G. List four things wrong with the capital budgeting agenda of the management of East Tacoma Works.
H. Compare “trade secrets” to “patents” in defending the value of a new process that you have created as the owner and
general manager of new company.
I. Your company has developed a new technology related to wireless internet communication. Two competing
technologies are being promoted by rivals in the industry. Only one of these technologies will likely survive and your
company must at least triple in size each year for the next three years in order to be that survivor. What will be the
personnel, quality, and financial risks to manage over the next 36 months?
CASE A (12 points)
[REVISITED. Quoted from the 2006 annual 10-K.] On February 25, 2006, the Pier 1 Company operated 1,100 Pier 1
stores in the United States, 83 Pier 1 stores in Canada, and supported five franchised stores in the United States.
Additionally, the Company operated 43 Pier 1 Kids stores located in the United States. The Company expects to expand
Pier 1 Kids nationally, offering value-oriented home furnishings for children and families. Growth plans include a catalog
and direct-to-consumer business as well as expanding the concept to approximately 250 stores over the next decade. The
Company supplies merchandise and licenses the Pier 1 Imports name to Sears Mexico and Sears Puerto Rico, which sell
Pier 1 merchandise primarily in a “store within a store” format in 26 Sears Mexico stores and in seven Sears Puerto Rico
stores. Company-operated Pier 1 stores in the United States and Canada average approximately 9,800 gross square feet,
which includes an average of approximately 7,800 square feet of retail selling space. The stores consist of freestanding
units located near shopping centers or malls and in-line positions in major shopping centers. Pier 1 operates in all major
United States metropolitan areas and many of the primary smaller markets. Pier 1 stores generally have their highest sales
volumes during November and December as a result of the holiday selling season.
The Company is in the highly competitive specialty retail business and competes primarily with specialty sections of
large department stores, furniture and decorative home furnishings retailers, small specialty stores, discount stores, and
catalog and Internet retailers. Management believes that the Company competes on the basis of price, value, rapidly
changing merchandise assortments, visual presentations of its merchandise, customer service, and fashion sense. The
Company also believes it remains competitive with other retailers because of its name recognition and established vendor
relationships. The Company believes that its Pier 1 Kids business offers an opportunity to take advantage of the growing
demand for children’s furniture and accessories.
Pier 1 offers a diverse selection of products consisting of approximately 3,000 items imported from over 40 countries
around the world. While the broad categories of Pier 1’s merchandise remain constant, individual items within these
product groupings change frequently in order to meet the demands of customers.
Pier 1 merchandise largely consists of items that require a significant degree of handcraftsmanship and are mostly
imported directly from foreign suppliers. For the most part, the imported merchandise is handcrafted in cottage industries
and small factories. Pier 1 is not dependent on any particular supplier and has enjoyed long-standing relationships with
many vendors and agents. The Company believes alternative sources of products could be procured over a relatively short
period of time, if necessary. In selecting the source of a product, Pier 1 considers quality, dependability of delivery and
cost. During fiscal 2006, Pier 1 sold merchandise imported from over 40 different countries with 35% of its sales derived
from merchandise produced in China, 14% derived from merchandise produced in India, 13% derived from merchandise
produced in the United States and 33% derived from merchandise produced in Indonesia, Brazil, Italy, Thailand, the
Philippines, Vietnam and Mexico. The remaining 5% of sales was from merchandise produced in various Asian, European,
Central American, South American and African countries.
Imported merchandise and a portion of domestic purchases are delivered to the Pier 1 distribution centers, unpacked
and made available for shipment to the various stores in each distribution center’s region. Due to the time delays involved
in procuring merchandise from foreign suppliers, Pier 1 maintains a substantial inventory to assure a sufficient supply of
products to its stores. Gross profit after related buying and store occupancy costs, expressed as a percentage of sales,
was 33.9% in fiscal 2006 compared to 38.5% a year ago. Merchandise margins, as a percentage of sales, declined from
53.1% in fiscal 2005 to 50.2% in fiscal 2006. The decline in merchandise margin rates resulted primarily from the
Financial and Managerial Accounting
Final Examination, Form A
Fall 2006
6
Company’s continued use of promotional discounts and clearance markdowns in an effort to stimulate sales as well as
make way for new and unique merchandise lines. Store occupancy costs during fiscal 2006 were $290.4 million or 16.3%
of sales, an increase of $24.1 million and 170 basis points over store occupancy costs of $266.3 million or 14.6% of sales
during fiscal 2005. This increase was primarily due to an inability to leverage relatively fixed rental costs over a lower sales
base.
REQUIRED:
1.
Over the past 3 years, Pier 1’s operating margin (earnings before interest and taxes) on sales decreased from 10%
to -2.4% of sales. Examining the income statement below, how much of this 12.4% decrease is attributable to a decrease
in gross margin (after cost of sales and occupancy) and how much is attributable to the efficiency of operations? What has
been the impact of the costs of occupancy as described above?
2. The ratio of market-value-to-book value for the stockholders’ equity is about 1.1. Why would this ratio be low rather
than a more normal 2.0 or a more desirable 3.0? Why has the ratio declined over the past 2 years?
3. There were 1,259 store managers working fir Pier 1 Imports. Prepare a suggested list of four performance measures to
be used to evaluate the performance of each store manager.
[See separate financial schedule]
CASE B (12 points) Wolverine Tube, Inc. (REVISITED.
Quoted From SEC 10-K of
March 15, 2006) Wolverine Tube, Inc. (the Company, Wolverine, we, our, or us) is a world-class quality manufacturer of
copper and copper alloy tube, fabricated products, metal joining products, and copper and copper alloy rod and bar
products. Our focus is on custom-engineered, higher value-added tubular products, including fabricated copper
components and metal joining products, which enhance performance and energy efficiency in many applications,
including: commercial and residential heating, ventilation and air conditioning, refrigeration, home appliances, industrial
equipment, power generation, petrochemicals and chemical processing.
We believe that our product line is the broadest of any North American manufacturer of copper and copper alloy tube,
which allows us to offer customers complete packaged solutions, and to pursue cross-selling opportunities. Our
technological expertise has helped us to establish strong and long-standing relationships with many of the leading original
equipment manufacturers (OEM) that use our higher value-added copper tube, and enables us to maintain a leading
market share in our most important product lines and geographic markets.
We have expanded our operations through acquisitions and international growth over the last six years. In late 2004,
we opened a new 130,000 square foot leased manufacturing facility to produce technical tube and fabricated products in
Monterrey, Mexico. Our investment in the Mexican facility at the end of 2005 totals approximately $4.4 million, $2.6 million
of which was from the relocation of equipment from other Wolverine facilities. In 2001, we invested approximately $9
million for the construction of a 33,000 square foot technical tube manufacturing facility in Esposende, Portugal, which
began commercial production in early 2002. In 2003, this facility began producing brazed assemblies for our European
customers. In 2000, we purchased the joining products business of Engelhard Corporation, a leading manufacturer of
brazing alloys, fluxes, and lead-free solder, based in Warwick, Rhode Island, for approximately $42 million.
…As of December 31, 2005, we had a total of 3,087 employees. Approximately 18% of our employees are represented by
unions comprised of a majority of the hourly employees at our Montreal, Quebec and Monterrey, Mexico facilities. Our
2005 operations and financial results were negatively affected by an organized work slow-down by hourly employees at
the Montreal the second quarter of 2005. The strike was settled on May 25, 2005.
Capital expenditures. In 2005, capital expenditures totaled $10.0 million versus $11.7 million in 2004 and $6.0 million in
2003. Capital expenditures include asset replacement, environmental and safety compliance, cost reduction, productivity
improvement items, and, in 2005 and 2004, expenditures for our Monterrey, Mexico manufacturing facility. We expect to
spend approximately $9 million on capital expenditures in 2006.
Research and development expense was $3.1 million in 2005, $3.5 million in 2004 and $2.9 million in 2003. With the
reductions made in the overall corporate functions in the third quarter 2005, we would anticipate a reduction in research
and development expense in 2006 relative to our 2005 expenditures. In addition to our Technology Center and China
research group, we utilize our manufacturing facilities and technical personnel to assist in continually improving our
manufacturing processes, as well as new product development as it relates to those manufacturing facilities.
Required: After reviewing the financial information below:
a. Using the 2003 and 2004 financial and quantity data, estimate the fixed and variable portions of “other manufacturing
costs”.
b. Compare Wolverine to its three competitors on revenue size and profitability.
c. List two options, other than bankruptcy, that Johann R. Manning, Jr., President and CEO, could reasonably consider to
increase the company value. Give one weakness and one strength for each option.
Financial and Managerial Accounting
Final Examination, Form A
WOLVERINE TUBE, INC.
Extracted information from the financial report (units in millions)
2005
2004
Net sales
$
874 100.0% $ 798
Cost of Copper
61.7%
539
438
Other Manufacturing Costs
35.9%
313
296
Cost of goods sold
97.5%
852
734
Gross profit
2.5%
22
64
Selling, gen., admin. expenses
4.2%
37
37
Income before interest and taxes
-1.8%
(15)
26
Interest expense, net
2.4%
21
21
Operating income from operations
-4.1%
(36)
6
Income tax provision/(benefit)
-0.2%
(2)
(2)
Income before other charges
-3.9%
(34)
7
All other charges
0.5%
4
7
Net income/(loss) (h)
-4.4%
(39)
0
Selling Price per pound
Copper Price per pound
Other Production Costs per
pound
Total Cost per pound
Pounds shipped
Total assets
Other liabilities
Total long-term debt
Stockholders’ equity
100.0%
54.9%
37.1%
92.0%
8.0%
4.7%
3.3%
2.6%
0.7%
-0.2%
0.9%
0.9%
0.0%
2005
$2.72
1.68
2004
$2.35
1.29
0.98
$2.66
320,568
2005
$568,765
170,543
234,920
$163,302
0.87
$2.16
339,417
2004
$587,458
140,934
237,022
$209,502
Fall 2006
2003
$ 596
265
290
555
41
32
9
21
(12)
(14)
1
42
(41)
7
100.0%
44.5%
48.7%
93.2%
6.8%
5.4%
1.5%
3.6%
-2.1%
-2.3%
0.2%
7.0%
-6.8%
2003
$1.82
0.81
0.89
$1.70
327,354
2003
$553,258
119,623
254,284
$179,351
ADDITIONAL INFORMATION:
Major plant locations in Decatur, AL; Shawnee, OK; Carrolton, TX; Booneville, MS; Altoona, PA; Montreal, QB; London,
ON; Shanghai, China; Esposende, Portugal; Monterey, Mexico
Market Capitalization as of 11/2/06: $17.3 million
On 11/1/06 at 3:32 PM, the company announced that it was considering reorganization under bankruptcy laws because of
the inability to meet long-term debt requirements.
From Yahoo Finance: Wolverine has three competitors: Mueller Industries (Rev = $2.45 B, Income= $179.5 M); Olin
Corp. (Rev=$4.0 B, income=$165 M) and Outokumpu Ovi (Rev=$9.73 B, income=$530 M).
CASE C (26 points)LYONDELL
CHEMICAL
(Excerpts are all exact quotes from the 10-K for 2006)
Lyondell’s products are basic chemicals and their derivatives that become building blocks for broadly used goods that are
integrally linked to the global economy. These goods include: clothing; packaging; construction, home building and home
improvement materials; household furnishings and automobile parts. Driven by the Company’s fundamental beliefs, Lyondell has
assembled a balanced, integrated product portfolio comprising four major business segments. Each plays a strategic role in creating
stakeholder value:
• Ethylene, co-products and derivatives. Lyondell is a leading North American producer of ethylene, propylene, polyethylene,
ethylene glycol and acetyls. Large scale operations and the operational flexibility to use the lowest-cost raw materials provide
competitive advantages. These highly cyclical businesses are capable of generating significant earnings and cash flow,
particularly during positive periods of the business cycle.
• PO and related products. Lyondell is a leading global producer and marketer of PO and derivatives, offering strength in
process technology in an industry that Lyondell believes provides growth opportunities both domestically and internationally.
• Inorganic chemicals. Lyondell is a leading producer of TiO2, offering state-of-the-art products in all major customer markets:
paints and coatings, plastics and paper. Lyondell believes that these businesses offer a less volatile stream of earnings over a
business cycle.
• Refining. Through its LCR joint venture with CITGO, Lyondell is a major refiner of heavy, high sulfur crude oil. LCR
Financial and Managerial Accounting
Final Examination, Form A
Fall 2006
8
operates under a crude oil supply contract that allows the realization of a predetermined margin on every barrel of oil it
refines under the contract. LCR provides strong cash generation under this supply contract. See “Refining Segment—Raw
Materials” for a description of the supply contract and the risks associated with the contract.
Since its spin-off from Atlantic Richfield Company (“ARCO”) in 1989, Lyondell has grown into one of the world’s largest
independent, publicly-traded chemical companies, with approximately $15 billion in assets and approximately 10,000 employees as of
December 31, 2005. Through 2005, Lyondell’s major achievements have included:
• the creation of LCR as a joint venture with CITGO in 1993, with LCR growing to its present form as a result of the completion of a
$1 billion upgrade of the refinery in 1997 that enabled the refinery to process heavy, high sulfur crude oil from the Bolivarian Republic
of Venezuela (“Venezuela”);
• the formation of Equistar as a joint venture with subsidiaries of Millennium in 1997, with the addition of subsidiaries of Occidental
Petroleum Corporation as partners in 1998;
• the acquisition of ARCO Chemical Company in 1998, which provided what is now the Company’s PO and related products segment;
…
• the 2002 acquisition by Lyondell of the partnership interests in Equistar owned by subsidiaries of Occidental Petroleum Corporation;
• the 2003 completion of a world-scale PO/SM plant in The Netherlands through a joint venture with Bayer, and the 2002 completion
of a world-scale BDO plant in The Netherlands using proprietary Lyondell PO-based technology;
• the completion of the consolidation of Equistar and the addition of two major lines of business, TiO2 and acetyls, through the
November 2004 acquisition of Millennium; and
•the repayment of $1.66 billion of debt from September 2004 through December 2005.
The Company’s businesses focus on having efficient, reliable operations, with an underlying goal to take advantage of areas of
strength and differentiation. In the ethylene, co-products and derivatives segment, the major emphasis is on maintaining low production
costs. Lyondell remains differential from the rest of the North American industry based on its ability to process crude oil-based liquid
raw materials, also known as heavy liquid raw materials, for a much greater percentage of the ethylene, co-products and derivatives
segment’s raw material requirements versus the industry. These heavy liquid raw materials historically have been cost-advantaged in
comparison to natural gas liquids-based raw materials, assuming the co-products were recovered and sold. In the PO and related
products segment, Lyondell’s strength takes the form of global presence and a leadership position in technology. Through its inorganic
chemicals segment, Lyondell is one of the major producers that possesses and practices, in approximately 77% of its capacity, the more
efficient chloride-based TiO2 technology, while also benefiting from the fact that it has TiO2 manufacturing sites in four regions of the
world. The refining segment’s major advantage lies with its ability to process heavy, high sulfur crude oil and its contractual supply
relationship with Petróleos de Venezuela, S.A. (“PDVSA”), the national oil company of Venezuela.
Operational Excellence
Through intense focus on Operational Excellence—Lyondell’s approach to continuous improvement in all aspects of its operations—
Lyondell continually seeks to maximize the value of each of the businesses in its portfolio. The actions of Lyondell’s employees have
led to:
•safety performance in 2005 that was among the best in the industry;
•significantly improved efficiencies by establishing and extending shared services arrangements, the principles of which have been
applied during the integration of the Millennium businesses;
•improved operational efficiency by shifting production to lower-cost, more efficient sites and simplifying production scheduling; and
•steady improvement of cash utilization through actions such as inventory reduction and increased operational efficiency.
Financial Strategy
Lyondell’s financial strategy is designed to maximize value for its stakeholders as it seeks to:
• maintain sufficient liquidity;
• repay debt; and
• achieve an investment-grade credit rating.
During recent industry trough conditions, liquidity had been a priority for Lyondell and was achieved through a combination of
Operational Excellence and a focus on sound financial management. From September 2004 through December 2005, with improving
business conditions, Lyondell repaid $1.66 billion of debt. Longer term, as industry conditions continue to provide the opportunity for a
significant level of profitability, the Lyondell business portfolio is designed to generate cash, which will continue to be directed toward
the repayment of debt. The Company’s goal is to improve its financial flexibility by achieving an investment-grade credit rating, which
the Company believes can be achieved following debt reduction and strengthening of the Company’s financial position.
[Additional assumption that is not in the 10-K. During 2005, Lyondell was operating at near their capacity for many of their
production facilities. CITGO is partially owned by the government of Venezuela.]
REQUIRED:
a. Assess the gross margin, general and administrative expenses, and research and development of Lyondell over the past four
years.
b. Lyondell produces general chemicals from various raw materials. How successful have they been with this strategy over the
past four years?
c. Lyondell has grown primarily by the acquisition of Equistar, ARCO Chemical, and Millenium over the past 8 years. Assess
the quality of the resulting Goodwill in comparison to the owner’s equity. (Specifically consider the relationship between
goodwill and net income and the financial risk taken on as liabilities.)
Financial and Managerial Accounting
d.
e.
f.
g.
h.
Final Examination, Form A
Fall 2006
9
Operating leases and pensions have been included on the balance sheet by the instructor. How would these amounts be
estimated?
How well is Lyondell achieving each of the objectives stated in their Financial Strategy above?
List four “Issues and Problems” for Lyondell.
One division of Lyondell turns petroleum based raw materials into the base for various resins and plastics. Assume that the
division employees about 1,000 people, has three production plants, and markets 10 forms of its product. Given the
Operational Excellence as above is one of the corporate goals, list balanced-score-card performance measures for the
division.
Recommend a capital budgeting process for considering the acquisition of new production plant and equipment.
[See separate financial reports.]