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Exercise 1

Kitchen, Inc. manufactures kitchen equipment. Shown below for the


current year is the income statements for the company and a common
size summary for the industry in which the company operates. (Notice
that the percentages in the right-hand column are not for Kitchen, Inc., but
are average percentages for the industry.)
Kitchen, Industry
Inc.
Average
Sales (net)....................................................... $15,000,000
100
%
Cost of goods sold...........................................
7,200,000
58
Gross profit on sales....................................... $ 7,800,000
42
%
Operating expenses:
Selling........................................................... $ 2,400,000
%
General and administrative..........................
700,000
26
Total operating expenses................................ $ 3,100,000
36
%
Operating income........................................... $ 4,700,000
%
Net income.................................................. $ 3,200,000
4
%
Prepare a two-column common size income statement. The first column
should show for Kitchen, Inc. all items expressed as a percentage
of net sales. The second column should show the equivalent
industry average for the data given in the problem. The purpose
of this common size statement is to compare the operating results
of Kitchen, Inc. with the average for the industry. (Round to the
nearest percent.)
a. Comment specifically on differences between Kitchen, Inc. and the
industry average with respect to gross profit on sales, selling
expenses, general and administrative expenses, operating income,
net income, and return on assets. Suggest possible reasons for the
more important disparities.
Exercise 2
Gibson Greeting, Inc. and American Greetings are two of the worlds largest publicly owned
manufacturers of greeting cards and gift wrap products. Shown below are data from the
companies recent annual reports.

Total current assets


Total current liabilities
Average total assets
Average total stockholders equity
Operating income
Net income

Gibson
Greetings, Inc.
$310,957,000
164,281,000
382,628,000
206,074,000
67,191,000
42,369,000

American
Greetings
$ 680,945,000
200,756,000
1,114,318,000
584,796,000
144,106,000
72,177,000

Required:
a) Compute the following for each company:
Current ratio; working capital; return on average total assets; and, return on

average total stockholders equity.


(50%)
b) From the view point of a short-term creditor, which of these companies
appears to have the greater short- term debt-paying ability? Explain.

(25%)

c) In which company does management appear to be using the resources under its
control most efficiently? Explain the reasons for your answer.

(25%)

Exercise 3
The loan officer at First Chicago Bank has the authority to issue loans up to $50,000 without
approval from a higher bank official. This week two small companies, Lumber jack Co. and
Bridal Studio Co., have each submitted a proposal for a six- month $50,000 loan.
To prepare financial analyses of the two companies, the loan officer obtained the information
summarised below:
Lumberjack Co. is a local lumber and home improvement company. Because sales
have increased so much during the past two years, Lumberjack has had to raise additional
working capital, especially as represented by receivables and inventory.
The $50,000 loan is needed to assure the company of enough working capital for the next
year. Lumberjack began the year with total assets of $740,000 and stockholders equity of
$260,000, and during the past year the company had a net income of $40,000 on net sales of
$760,000.
The companys current unclassified balance sheet appears as follows:
`
Assets
Liabilities and Stockholders Equity
Cash
$ 30,000
Accounts Payable
$200,000
Accounts Receivable (net) 150,000
Notes Payable (short term)
100,000
Inventory
250,000
Notes Payable (long term)
200,000
Land
50,000
Common Stock
250,000
Building (net)
250,000
Retained Earnings
50,000
Equipment (net)
70,000
------------Total Liabilities &
-------------Total Assets
$ 800,000
Stockholders Equity
$ 800,000
The Bridal Studio has for three years been a successful clothing store for young professional
women. The leased store is located in the downtown financial district.
Bridals loan proposal asks for $50,000 to pay for stocking a new line of womens garments
during the coming season. At the beginning of the year, the company had total assets of
$200,000 and total stockholders equity of $114,000. Over the past year, the company earned
a net income of $36,000 on net sales of $480,000. The firms unclassified balance sheet at
the current date appears as follows:
Assets
Liabilities and Stockholders Equity
Cash
$ 10,000
Accounts Payable
$ 80,000
Accounts Receivable (net)
50,000
Accrued liabilities
10,000
Inventory
135,000
Common Stock
50,000
Prepaid Expenses
5,000
Retained Earnings
100,000
Equipment (net)
40,000
------------------------Total Liabilities and
Total Assets
$ 240,000
Stockholders Equity
$ 240,000
Required:
a. i. Prepare a financial analysis of each companys liquidity position before and after
receiving the proposed loan.
ii.
Briefly describe the effects of the proposed loan on each companys financial
position.
b. i. Calculate any profitability ratios you think may be relevant.

ii. In the light of your findings in answering question a and b.i. and other financial
information provided in the case, what positive and negative factors could affect each
company's ability to pay back the loan in the next year?
iii. On the basis of the information you have at your disposal, to which company would
the bank be more willing to make a $50,000 loan?
iv. What other information of a financial or non-financial nature would be helpful for
making a final decision?

Exercise 4
Shown below are selected financial data for Fabulous World and Imports, Inc. at the end of
the current year:
Fabulous World
Net credit sales
Cost of goods sold
Cash
Accounts receivable (net)
Inventory
Current Liabilities

Imports Inc.

$675,000
504,000

$560,000
480,000

51,000
75,000
84,000
105,000

20,000
70,000
160,000
100,000

Assume that the year-end balances shown for accounts receivable and for inventory also
represent the average balances of these items throughout the year.
REQUIRED:

a. For each of the two companies compute the following:


Working capital, Current ratio, and Quick ratio.
b. Compute the number of times inventory turned over during the year,
and the average number of days required to turnover over inventory.

c. Compute the number of times accounts receivable turned over during the year, and the
d.

average number of days required to collect accounts receivable. Also the operating
cycle.
From the viewpoint of a short-term creditor, comment upon the quality of each
companys working capital. To which company would it be preferable to sell $20,000 in
merchandise on a 30 day open account?

Exercise 5
Sambito Products Company has been disappointed with its operating results for the past two
years. As the accountant for the company, you have the following information available:
2015
2014
Current Assets
Total Assets
Current Liabilities
Long-term Liabilities
Owners Equity
Net Sales
Net Income

$ 90,000
290,000
40,000
40,000
210,000
524,000
32,000

$ 70,000
220,000
20,000
-----200,000
400,000
22,000

Total assets and owners equity at the beginning of 2014 were $180,000 and $160,000
respectively.

REQUIRED:
a. Compute the following measures of liquidity for both years: (1)
working capital and (2) current ratio. Comment on the differences
between the years.

b. Compute the following measures of profitability for both years: (1) profit margin, (2)
asset turnover, (3) return on assets, (4) debt to equity, and (5) return on equity.
Comment on the change in performance from2007 to 2008.

Exercise 6
Shown below are selected data from the financial statements of Bouras Stores, a retail
lighting store:
From the balance sheet:
Cash
Accounts receivable
Inventory
Plant assets (net of accumulated depreciation)
Current liabilities
Total stockholders equity
Total assets
From the income sheet:
Net sales
Cost of goods sold
Operating expenses
Interest expense
Income taxes expense
Net income

40,000
165,000
215,000
600,000
185,000
400,000
1,200,000
$2,000,000
1,600,000
300,000
75,000
5,000
20,000

Required:
a. Compute the following (round to one decimal place):
Current ratio
Quick ratio
Working capital
Debt Equity ratio
Comment on these measurements and evaluate Bouras short-term debit-paying
ability.
b. Compute the following ratios (assume that the year-end amounts of total assets and
total stockholders equity also represent the average amounts throughout the year):
Return on assets
Return on equity
Comment on the companys performance under these measurements. Explain
why the return on assets and return on equity are so different.
c. Discuss (1) the apparent safety of long-term creditors claims and (2) the
prospects for Bouras Stores continuing its dividend payments of 25,000 annually.

Exercise 7
Pace Leisure Ltd. a designer and manufacturer of casual and leisure clothes aimed
particularly at the younger, higher income market.
The financial reports for two years are provided below. You are to compute all the ratios that
the data allows for and comment on the companys performance over two the years.

Balance sheets ended Dec. 31st 000


2014

2015

Current Assets
Cash
Accounts Receivable

56
1,882

Current Assets
Cash
Accounts Receivable

8
4,346

Inventories
Total

2,418
4,356

Inventories
Total

5,820
9,974

Long Term Assets

8,600

Long Term Assets

Total Assets
Liabilities
Short-Term
Accounts Payable
Other short-term
liabilities
Taxes payable
Bank overdraft
Total short-term
Long Term Liabilities
Bank Loan
Total Liabilities
Equity
Shareholders Capital
Ordinary shares 1
each
Retained Profit
Total Equity
Total L & SE

12,956

Total Assets

420
600
2,482

Liabilities
Short-Term
Accounts Payable
Other short-term
liabilities
Taxes payable
Bank overdraft
Total short-term

3,600
6,082

Bank Loan
Total Liabilities

3,600

Shareholders Capital
Ordinary shares 1 each

1,214
248

3,274
6,874
12,956

14,470
14,470
24,444

2,612
402
780
5,050
8,844
6,600
15,444
3,600

Retained Profit
Total Equity
Total L & SE

Income Statements for the years ended Dec. 31st 000


2014
Sales
14,006
Cost of Goods sold
7,496
Gross Profit
6,510
Operating Expenses
4,410
Operating Profit (before
2,100
interest & taxation
Interest Payable
432
Profit before taxation
1,668
Taxation
420
Profit after taxation
1,248

5,400
9,000
24,444

2015
22,410
11,618
10,792
6,174
4,618
912
3,706
780
2,926

Changes in Shareholders Equity Dec. 31st 000


2014
2015
Shareholders Capital
Shareholders Capital
Ordinary shares 1 each
3,600
Ordinary shares 1 each
3,600
Retained Profit brought forward from previous Retained Profit brought forward from previous
years
2,626
years
3,274

Profit (after tax) for the year


Dividend paid
Retained Profit carried forward
Total Equity

1,248
(600)
3,274
6,874

Profit (after tax) for the year


Dividend paid
Retained Profit carried forward
Total Equity

2,926
( 800)
5,400
9,000

G. Pavlou is employed as a bank loan officer for Beta Bank. He is comparing two
companies that have applied for a loan, and he wants your help in evaluating
those companies. The two companiesPurple, Inc. and Orange Companyare
approximately the same size and had approximately the same cash balance at the
beginning of 2010. Because the total cash flows for the three-year period are
virtually the same, he is inclined lo evaluate the two companies as equal in terms
of their desirability as loan candidates. Abbreviated information (in thousands of
dollars) from Purple, Inc., and Orange Company is as follows:
Purple,
Inc.

Orange
Co.

2010

2011

2012

2010

2011

2012

Operating activities
Investing activities

$10
(5)

$13
(8)

$15
(10)

$8
(7)

$3
(5)

$(2)
8

Financing activities

(3)

12

-0-

$13

$2

$6

$13

$2

$6

Cash flows from:

Net from all activities

Required:
a. Do you agree with the loan officers preliminary assessment that the two
companies are approximately equal in terms of their strength as loan
candidates. Explain.
(60%)
b. What might account for the fact that Orange Company's cash flow from
financing activities is zero in 2012?
(20%)
c. Generally, what would you advise him with regard to using statements of
cash flows in evaluating loan candidates?
(20%)

Exercise 9
Companies offering services to the computer technology industry are growing quickly.
Participating in this growth, Northeast Servotech Corporation has expanded rapidly in
recent years. Because of its profitability, the company has been able to grow without
obtaining external financing. This is reflected in its current balance sheet, which contains
no long- term debt. The liability and stockholders equity sections of the balance sheet on
March 31,2015 follows:

Northeast Servotech Corporation


Partial Balance Sheet
March 31, 2015
Current Liabilities
Stockholders Equity:
Common Stock- $10 par value, 500,000 shares
authorised, 100,000 shares issued and outstanding
Paid-in Capital in Excess of Par Value,
Retained Earnings
Total Stockholders Equity
Total Liabilities and Stockholders Equity

$ 500,000

$1,000,000
1,800,000
1,700,000
-----------------4,500,000
----------------$5,000,000

The company now has the opportunity to double its size by purchasing the operations of a
rival company for $4,000,000. If the purchase goes through, Northeast Servotech will become
the top company in its specialised industry in the northeastern part of the country. The
problem for management is how to finance the purchase. After much study and discussion
with bankers and underwriters, management has prepared three financing alternatives to
present to the board of directors, which must authorise the purchase and the financing.
Alternative A : The company could issue $4,000,000 of long-term debt. Given the companys
financial rating and the current market rates, management believes the company will have to
pay an interest rate of 17 percent on the debt.
Alternative B: The company could issue 40,000 shares of 12%, $100 par value preferred
stock.
Alternative C: The company could issue 100,000 additional shares of $10 par value common
stock at $40 per share.
Management explains to the board that the interest on the long-term debt is tax-deductible
and that the applicable income tax rate is 40 percent. The board members
know that a dividend of $0.80 per share of common stock was paid last year, up from
$0.60 and $0.40 a per share in the two years before that. The board has had a policy of
regular increases in dividends of $0.20 per share. The board feels that each of the three
financing alternatives is feasible and now wants to study the financial effects of each
alternative.
REQUIRED:
a. Prepare a schedule to show how the liabilities and the stockholders equity sections
of Northeast Servotechs balance sheet would appear under each alternative and
compute the debt to equity ratio for each.
b. i Compute and compare the cash needed to pay the interest or dividends for each kind
of new financing net of income taxes in the first year.
ii How might the cash needed to pay for the financing change in the future years?
a. Evaluate the alternatives, giving arguments for and against each one of the
alternatives.