Chapt

er2

Di
scussi
onQuest
ions
2-
1. Di
scusssomef
inanci
alv
ari
abl
est
hataf
fectt
hepr
ice-
ear
nings,
rat
io.

Thepr i
ce-
earni
ngsr at
iowill
bei nfluencedbyt heearni
ngsandsal es
growthofthefirm,theri
skorv olatil
i
tyinper formance,t
hedebt -
equit
y
struct
ureoft
hef ir
m, t
hedividendpay mentpol icy
,thequali
tyof
management ,andanumberofot herfactors.Ther at
iotendstobefutur
e
-ori
ented,
andt hemor eposi
tivetheout look,thehigheritwil
lbe.

2-
2. Whati
sthediff
erencebet
weenbookv
aluepershareofcommonst
ock
andmarketv
aluepershar
e?Whydoesthi
sdispar
it
yoccur?

Bookv aluepershar eisar r

ivedatbyt aki
ngthecostoft heasst sand
subtractingoutl iabili
ti
esandpr efer
redstockanddi v
idingbyt henumber
ofcommonshar esout standing.I ti
sbasedont hehistoricalcost soft he
assets.Mar ketv al
uepershar ei sbasedoncur r
entassessedv al
ueoft he
fi
rmi nthemar ketplaceandmaybearl i
tt
lerelat
ionshipt oor i
ginal cost.
Besidest hedi spar i
tybet weenbookandmar ketvaluecausedbyt he
hi
storical costappr oach, othercont ri
buti
ngf actorsaret hegr owt h
prospect sfort hef i
rm, thequal ityofmanagement ,andt heindust ry
outl
ook.Tot heext entthesear equitenegati
v eorposi t
ive, mar ketvalue
maydi fferwi delyfrom bookv al
ue.

2-
3. Expl
ainhowdepr
eci
ati
ongener
atesact
ual
cashf
lowsf
ort
hecompany
.

Theonlywaydepr eciat
iongenerat
escashflowsforthecompanyisby
serv
ingasataxshi el
dagainstreport
edincome.Thisnon-cash
deducti
onmaypr ovidecashflowequal t
othetaxrat
et i
mest he
depreci
ati
oncharged.Thismuchi ntaxeswill
besaved,whilenocash
paymentsoccur.

2-
4. Whatisthedif
fer
encebetweenaccumulateddepr
eci
ati
onand
depr
eciat
ionexpense?Howaretheyrel
ated?

Accumul ateddepr eci

ati
onisthesum ofall pastandpresent
depreciat
ionchar ges,whil
edepreci
ationexpensei sthecurr
entyear
's
charge.Theyar erelat
edinthatthesum ofal lpri
ordepreci
ati
onexpense
shouldbeequal t
oaccumul at
eddepr eciat
ion(subjecttosome
dif
ferenti
al r
elat
edt oassetwrit
e-of
fs).

S-
4
 Howi
sthei
ncomest
atementr
elat
edt
othebal
ancesheet
?
2-
5.
Theear nings(l
essdiv
idends)r
epor t
edi nt
heincomest at
ementis
transfer
redtotheownershipsectionofthebalancesheetasr
etai
ned
earnings.Thus,whatweearnint heincomestatementbecomespartof
theowner shipi
nter
estinthebalancesheet.

2-
6. Commentonwhyinf
lat
ionmayr
est
ri
ctt
heusef
ulnessoft
hebal
ance
sheetasnor
mal
l
ypresent
ed.

Thebalancesheetisbasedonhist
ori
calcost
s.Whenpr
icesareri
sing
rapi
dly
,hist
ori
calcostdatamaylosemuchofthei
rmeaning–par
ti
cular
ly
forpl
antandequipmentandinventor
y.

2-
7. Explai
nwhythest
atementofcashf
lowsprovidesusef
ulinfor
mat
ion
thatgoesbey
ondincomestat
ementandbalancesheetdata.

Theincomestat
ementandbal ancesheetarebasedont heaccrual
methodofaccounti
ng,whichatt
emptstomat chrevenuesandexpenses
i
ntheperiodi
nwhicht heyoccur
.Howev er
,accr
ualaccountingdoesnot
at
tempttoproper
lyassessthecashflowpositi
onofthef i
rm.The
st
atementofcashflowsfulf
il
lsthi
sneed.

2-
8. Whatarethet
hreepr
imar
ysecti
onsofthest
atementofcashf
lows?I
n
whatsect
ionwouldt
hepaymentofacashdi
videndbeshown?

Thesect
ionsoft
hest
atementofcashf
lowsar
e:

Cashf
lowsf
rom operat
ingact
ivi
ti
es
Cashf
lowsf
rom i
nvesti
ngacti
vit
ies
Cashf
lowsf
rom fi
nanci
ngacti
vit
ies

Thepay
mentofcashdi
vi
dendsf
all
sint
othef
inanci
ngact
ivi
ti
es
cat
egor
y.

S-
5
2-
9. Whati
sfr
eecashf
low?Whyi
siti
mpor
tantt
olev
eragedbuy
out
s?

Fr
eecashf
lowi
sequal
tocashf
lowf
rom oper
ati
ngact
ivi
ti
es:

Mi
nus: Capit
alexpendi
tur
esrequi
redt
omai
ntai
nthepr
oduct
ive
capaci
tyofthefi
rm.

Mi
nus: Di
vidends(
requi
redt
omaintai
nthepayoutoncommon
st
ockandtocoveranypr
eferr
edstockobl
igat
ion)
.

Theanalystorbankernormallylooksatfreecashf
lowtodet
ermine
whetherther
eareinsuffi
cientexcessfundstopaybackthel
oan
associ
atedwiththelever
agedbuy -
out
.

2-
10. Whyisinter
estexpensesaidtocostt
hefi
rm subst
anti
all
ylessthant
he
act
ualexpense,whil
ediv
idendscosti
t100percentoft
heout l
ay?

Int
erestexpenseisataxdeduct
ibleit
em t
othecorporat
ion,
whil
e
divi
dendpay mentsarenot
.Thenetcosttothecorpor
ati
onofint
erest
expenseistheamountpaidmultipl
iedbythedi
ff
erenceof(oneminus
theappli
cabletaxrat
e).

S-
6
Pr
obl
ems

2-
1. Franti
cFastFoodshadear ni
ngsaf t
ertaxesof$390, 000inthey ear2000
with300,000sharesoutstanding.OnJanuar y1,2001, t
hef i
rmissued
25,000newshar es.Becauseoft heproceedsfrom thesenewshar esand
otheroperat
ingimprovement s,ear
ningsaftertaxesincreasedby20
percent.

a.Comput
eear
ningspershar
efort
hey
ear2000.
b.Comput
eear
ningspershar
efort
hey
ear2001.

Sol
uti
on:
Fr
ant
icFastFoods

a.Year2000

b.Year2001

S-
7
2-
2. Gi
venthefoll
owinginf
ormat
ion,
prepar
e,i
ngoodf
orm,
ani
ncome
st
atementfortheDental
Dri
l
li
ngCompany.

Sel
li
ngandadmi ni
str
ati
veexpense $60,
000
Depreciat
ionexpense 70,
000
Sal
es 470,
000
I
nterestexpense 40,
000
Costofgoodssol d 140,
000
Taxes 45,
000

Sol
uti
on:
DentalDr
il
li
ngCompany
IncomeStat
ement

Sal
es $470,
000
Costofgoodssol d $140,
000
GrossPr of
it $330,
000
Sel
li
ngandadmi ni
strati
veexpense $60,000
Depreciati
onexpense $70,000
Oper at
ingprof
it $200,
000
I
nterestexpense $40,000
Earningsbefor
et axes $160,
000
Taxes $45,000
Earningsaft
ertaxes $115,
000

S-
8
 Preparei
ngoodf or
m ani
ncomestat
ementforATM Cards,
Inc.Takey
our
2-
3. calcul
ati
onsal
lthewaytocomput
ingear
ningspershar
e.

Sales $800,
000
Sharesoutstandi
ng 100,
000
Costofgoodssol d 300,
000
I
nterestexpense 20,
000
Sell
ingandadmi ni
str
ati
veexpense 40,
000
Depreciat
ionexpense 30,
000
Prefer
redstockdivi
dends 80,
000
Taxes 110,
000

Sol
uti
on:
ATM Car
ds,I
nc.
I
ncomeStatement

Sales $800,000
Costofgoodssol d 300,
000
Grosspr of
it $500,000
Sell
ingandadmi ni
strati
veexpense 40,
000
Depr eciati
onexpense 30,
000
Oper at
ingpr ofit $430,000
I
nter estexpense 20,
000
Earningsbef oret axes $410,000
Taxes 110,
000
Earningsaf tertaxes $300,000
Preferredst ockdi vi
dends 80,
000
Earningsav ail
abletocommonst ockhol
ders
220,000
Shar esout standing 100,
000
Earningspershar e $2.20

S-
9
2-
4. Censor edBooks, I
nc.sol
d1,400t extbooksfor$100eacht oHighTuiti
on
Universityi
n2001.Thesebookscost$71t oproduce.CensoredBooks
spent$5, 000(sell
i
ngexpense)t oconv i
ncetheUniversi
tytobuyit
sbooks.
Inaddition,CensoredBooksbor r
owed$46, 000onJanuar y1,2001,on
whicht hecompanypai d10per centinter
est.Bothi
nterestandpri
ncipal
werepai donDecember31, 2001.Thepubl i
shingfi
rm'staxratei
s30
percent.Depreciat
ionexpensefort heyearwas$8,000.

Di
dCensoredBookCompanymakeaprof
iti
n2001?Pl
easev
eri
fywi
than
i
ncomestatementpr
esent
edi
ngoodf
orm.

Sol
uti
on:
CensoredBooks,I
nc.
IncomeStatement
Fort
heYearEndingDecember31,
2001

Sal
es( 1,400booksat$100each) $140,
000
Costofgoodssol d(1,400booksat$71each)
99,
400
Grosspr of
it $40,600
Sel
li
ngexpense 5,
000
Depreciati
onexpense 8,
000
Oper ati
ngprof
it $27,600
I
nterestexpense 4,
600
Earningsbefor
et axes $23,000
Taxes@ 30% 6,
900
Earningsaft
ertaxes $16,100

2-
5. LemonAut oWhol esalershadsalesof$700, 000in2001andcostof
goodssol drepresented70per centofsales.Sell
ingandadminist
rat
ive
expenseswer e12per centofsales.Depr
eciationexpensewas$10,000
andinterestexpensef ortheyearwas$8, 000.Thef i
rm'staxr
ateis30
percent.

a.Computeear ni
ngsaf t
ertaxes.
b.Assumet hefir
m hiresMs.Car r,
aneff
ici
encyexpert
,asaconsul tant
.
Shesuggeststhatbyi ncreasi
ngsel
li
ngandadmi ni
str
ati
v eexpensest o
14percentofsales,salescanbeexpandedto$750,000.Theext ra
sal
eseffortwil
lalsoreducecostofgoodssoldto66per centofsales
(t
herewil
l bealargermakeupi npri
cesasaresultofmoreaggr essiv
e

S-
10
 sel
ling).Depreci
ationexpensewi l
lremainat$10,000.Howev er,more
automobi leswil
lhav etobecarri
edi ni
nventorytosati
sfycustomers,
andi nter
estexpensewi llgoupto$15,000.Thef i
rm'staxrat
ewi ll
remai nat30per cent.Computerevisedearni
ngsaf t
ertaxesbasedon
Ms.Car r
'ssuggestionsforLemonAut oWhol esal
ers.Wil
lherideas
i
ncreaseordecr easepr ofit
abi
li
ty?

Sol
uti
on:
LemonAutoWholesal
es
IncomeSt
atement

a.Sal
es $700,
000
Costofgoodssol d( 70%ofsal es) $490,
000
Gr ossProf
it $210,
000
Sel
lingandadmi nist
r at
iveexpense
(12%ofsal es) $84,000
Depreciati
on $10,000
Oper at
ingprofit $116,
000
I
nterestexpense $ 8,000
Ear ni
ngsbefor etaxes $108,
000
Taxes@ 30% $32,400
Ear ni
ngsaftertaxes $75,600

b.Sal
es $750,
000
Costofgoodssol d( 66%ofsal es) $495,
000
Gr ossProf
it $255,
000
Sel
lingandadmi nist
r at
iveexpense
(14%ofsal es) $105,
000
Depreciati
on $10,000
Oper at
ingprofit $140,
000
I
nterestexpense $15,000
Ear ni
ngsbefor etaxes $125,
000
Taxes@ 30% $37,500
Ear ni
ngsaftertaxes $87,500

Ms.Car
r'
sideawi
l
lincr
easepr
ofi
tabi
l
ity
.

S-
11
2-
6. Cl
assi
fyt
hef
oll
owi
ngbal
ancesheeti
temsascur
rentornoncur
rent
.

Retainedearnings Bondspay abl

e
Accountspay able Accruedwagespay abl
e
Prepaidexpenses Accountsreceivable
Pl
antandequi pment Capitali
nexcessofpar
I
nv entor
y Pref
er r
edstock
Commonst ock Marketablesecurit
ies

Sol
uti
on:

Retainedear nings–noncur r
ent
Account spay able–current
Prepai dexpense–cur rent
Pl
antandequi pment–noncur rent
I
nv ent ory–cur r
ent
Commonst ock–noncur r ent
Bondspay able–noncur rent
Accr uedwagespay abl
e–cur rent
Account srecei v
able–cur rent
Capit al i
nexcessofpar–noncur r
ent
Prefer redstock–noncur rent
Mar ket ablesecur i
ti
es–cur rent

S-
12
2-
7. Ar
rangethefol
lowi
ngincomestat
ementi
temssot
heyar
eint
hepr
oper
or
derofanincomestatement
:

Taxes Ear
ningspershare
Grosspr of
itsharesoutst
andi
ng Ear
ningsbeforet
axes
I
nterestexpense Costofgoodssold
Depreciati
onexpense Ear
ningsaft
ertaxes
Preferr
edst ockdiv
idends Ear
ningsavail
abl
et ocommon
Oper at
ingprofi
t st
ockhol
ders
Sales Sel
li
ngandadmi nist
rat
iveexpenses
Grosspr of
it

Sol
uti
on:

Sales
Costofgoodssol d
Grosspr ofit
Sell
ingandadmi nistrati
veexpense
Depr eciati
onexpense
Oper at
ingpr ofi
t
I
nter estexpense
Earningsbef oret axes
Taxes
Earningsaf t
ert axes
Preferredst ockdiv i
dends
EarningsAv ail
abletoCommonSt ockhol
der
s
Shar esOut standing
Earningspershar e

S-
13
2-
8. I
dent
if
ywhet
hereachoft
hef
oll
owi
ngi
temsi
ncr
easesordecr
easescash
f
low:

I
ncreaseinaccountsrecei
vabl
e Decreasei
nprepaidexpenses
I
ncreaseinnotespayable I
ncreaseini
nventory
Depreciat
ionexpense Di
videndpayment
I
ncreaseininvestment
s I
ncreaseinaccr
uedexpenses
Decreaseinaccountspayabl
e

Sol
uti
on:

I
ncr easeinaccount srecei
vable–decr easescashf l
ow
(use)
I
ncr easeinnotespay able–i ncreasescashf l
ow
(sour ce)
Depr eciat
ionexpense–i ncreasescashf low( source)
I
ncr easeininvestments–decr easescashf l
ow( use)
Decr easeinaccountspay able–decr easescashf low
(use)
Decr easeinprepaidexpense–i ncreasescashf l
ow
(sour ce)
I
ncr easeininventory–decr easescashf l
ow( use)
Divi
dendpay ment–decr easescashf l
ow( use)
I
ncr easeinaccruedexpenses–i ncreasescashf l
ow
(sour ce)

S-
14
2-
9. OkraSnackDeli
ghts,
Inc.hasanoperat
ingpr of
itof$210,
000.I
nter
est
expensefort
heyearwas$30,000;pr
eferreddivi
dendspaidwere$24,
700;
andcommondi vi
dendspaidwere$36,000.Taxeswer e$59,
300.Thefi
rm
has16,000shar
esofcommonst ockout standi
ng.

a.Cal
cul
atet
heearningspershareandt
hecommondivi
dendspershar
e.
b.Whatwasthei
ncreaseinret
ainedear
ningsf
ort
hey
ear?

Sol
uti
on:
Okr
aSnackDel
i
ght
s,I
nc.

a.Operati
ngprofit(EBIT) $210,
000
I
nterestexpense 30,
000
Earni
ngsbef or
et axes(EBT) $180,
000
Taxes 59,
300
Earni
ngsaftertaxes( EAT) $120,
700
Prefer
reddividends 24,
700
Avail
abletocommonst ockhol
der
s $96,000
Commondi vidends 36,
000
I
ncreaseinretainedear ni
ngs $60,000

b.I
ncr
easei
nret
ainedear
nings=$60,
000

2-
10. Quant
um Technol
ogyhad$640,
000ofr
etai
nedear
ningsonDecember31,

S-
15
 2001.Thecompanypaidcommondi vi
dendsof$30,000in2001andhad
ret
ainedearni
ngsof$500,
000onDecember31, 2000.Howmuchdi d
Quantum Technol
ogyearnduri
ng2001,andwhatwoulditsear
ningsper
sharebeif40,
000sharesofcommonstockwereout st
anding?

Sol
uti
on:
Quant
um Technol
ogy

Retainedear ni
ngs,December31, 2002 $640,000
Less: Ret
ainedearnings,December31,1999
500,000
Changei nret
ainedearni
ngs $140,
000
Add: Commonst ockdivi
dends 30,
000
Earningsav ail
abl
etocommonst ockhol
ders $
170,000

Ear
ningspershar
e

2-
11. Coastal Pipel
i
ne,Inc.ant
ici
pat
edcashf lowfr
om operati
ngacti
vit
iesof$8
mil
li
oni n2002.Itwi l
lneedtospend$1.5mi l
l
iononcapital
inv
estment si
n
or
dert or emaincompet i
ti
vewit
hini
t si
ndustr
y.Commonst ockdividends
ar
eproj ectedat$.6mi l
li
onandpreferr
edstockdi
videndsat$.25mi l
li
on.

a.Whati
sthefi
rm'
sproject
edfreecashfl
owfortheyear2002?
b.Whatdoest
heconceptoffr
eecashflowrepr
esent
?

Sol
uti
on:
Coast
alPi
pel
i
ne,
Inc.
a.Cashflowf rom operati
onsact
ivi
ti
es$8.00 mi
l
li
on
-Capi
tal Expendit
ures 1.50
-Commonst ockdi
vidends .60
-Pref
erredst ockdivi
dends .25
Fr
eecashf low $5.65 mil
li
on

b.Fr
eecashf
lowr
epr
esent
sthef
undst
hatar
e

S-
16
 avai
l
ableforspeci
alf
inanci
alact
ivi
ti
es,
suchasa
l
everagedbuyout.

2-
12. Fi
l
lint
hebl
ankspaceswi
thcat
egor
ies1t
hrough7bel
ow:

1.Bal
ancesheet(BS). 5.Currentl
iabi
li
ti
es( CL)
.
2.I
ncomest at
ement(IS). 6.Long-ter
ml i
abil
it
ies(LL)
.
3.Cur
rentassets(CA). 7.Stockholder
s'equity(
SE).
4.Fi
xedassets(FA).

Indicate
Whet herIt
em is
onBal ance
Sheet( BS)or IfonBal ance
Income Sheet,
Statement( IS) Designate I
tem
_
_____ _
_______ Whi chCat egor
y Ret ainedear nings
_
_____ _
_______ _
____ __
_______ I
ncomet axexpense
_
_____ _
_______ _
____ __
_______ Account srecei vable
_
_____ _
_______ _
____ __
_______ Commonst ock
_
_____ _
_______ _
____ __
_______ Capi t alinexcessofparv al
ue
_
_____ _
_______ _
____ __
_______ Bondspay able,mat uri
ty2005
_
_____ _
_______ _
____ __
_______ Not espay able( sixmont hs)
_
_____ _
_______ _
____ __
_______ Neti ncome
_
_____ _
________ _
____ __
________
_ Sellingandadmi nistr
ati
veexpenses
_
_____ _
________ _
____ __
_____ I
nv ent ori
es
_
_____ _
_____ _
____ __
________
_ Accr uedexpenses
_
_____ _
________ _
____ __
_____ Cash
_
_____ _
______ _
____ __
_______ Plantandequi pment
_
_____ _
________ _
____ __
_______ Sales
_
_____ _
______ _
____ __
_______ Oper atingexpenses
_
_____ _
_______ _
____ __
_______ Mar ket abl
esecur it
ies
_
_____ _
_______ _
____ __
_______ Account spay abl e
_
_____ _
_______ _
____ __
_______ I
nt er estexpense
_
_____ _
_______ _
____ __
_______ I
ncomet axpay able
_
____ __
_______

Sol
uti
on:

1.Bal
anceSheet(BS)
2.I
ncomeSt at
ement(IS)
3.Cur
rentAssets(CA)
4.Fi
xedAssets(FA)

S-
17
 5.CurrentLiabi
li
ties(CL)
6.Long-Term Liabil
it
ies(LL)
7.StockholdersEquity(SE)

I
ndicate I
ftheI t
em
Whether i
son
theit
em is Bal
ance
onIncome Sheet,
Stat
ement Designate
orBalance Which I
tem
Sheet Category
BS SE Ret ainedEar nings
IS I
ncomeTaxExpense
BS CA Account sRecei vable
BS SE CommonSt ock
BS SE Capi t alinexcessofparv alue
BS LL Bondspay ablemat uri
ty2005
BS CL Not esPay abl e(6mont hs)
IS Neti ncome( Ear ni
ngsaftertaxes)
IS SellingandAdm.Exp.
BS CA I
nv ent ori
es
BS CL Accr uedexpenses
BS CA Cash
BS FA Plant&equi pment
IS Sales
IS Oper atingexpenses
BS CA Mar ket abl
esecur i
ti
es
BS CL Account spay able
IS I
nt er estexpense
BS CL I
ncomet axpay abl
e

S-
18
S-
19
2-
13. TheJupi t
erCorporat
ionhasagrossprofi
tof$700,
000and$240,000in
depreciat
ionexpense.TheSatur
nCorporat
ional
sohas$700,
000i ngross
prof
it,wit
h$40,000indepreci
ati
onexpense.Sel
l
ingandadmini
strat
ive
expenseis$160,000foreachcompany.

Giv
enthatt
hetaxrat
eis40percent
,computet
hecashf
lowf
orboth
compani
es.Expl
aint
hedif
fer
enceincashfl
owbet
weenthet
wofir
ms.

Sol
uti
on:
Jupi
terCor
por
ati
on–Sat
urnCor
por
ati
on

Jupi
ter Satur
n
Grosspr ofit $700,
000 $700,
000
Sell
ingandadm.expense 160, 000 160,
000
Depreciation 240,
000 40,
000
Operati
ngpr of
it $300,
000 $500,
000
Taxes( 40%) 120,
000 200,
000
Earni
ngsaf t
ertaxes $180,
000 $300,
000
Plusdepr eciat
ionexpense $240,
000 $40,
000
CashFl ow $420,
000 $340,
000

Jupi
terhad$200,
000morei
ndepreci
ati
onwhich
prov
ided$80,
000(0.
40*$200,
000)moreincashfl
ow.

S-
20
2-
14. Ar
ranget
hef
oll
owi
ngi
temsi
npr
operbal
ancesheetpr
esent
ati
on.

Accumul ateddepr eciat

ion $300,
000
Retainedear nings 96,
000
Cash 10,
000
Bondspay abl e 136,
000
Account srecei v
able 48,
000
Pl
antandequi pment—or i
ginal cost 680,
000
Account spay able 35,
000
All
owancef orbaddebt s 6,
000
Commonst ock$1par ,
100, 000shar esoutstanding 100,
000
I
nv entory 66,
000
Preferredst ock, $50par,1,000shar esoutstanding 50,
000
Mar ketablesecur i
ti
es 20,
000
I
nv estment s 20,
000
Not espay able 33,
000
Capi t
al pai
di nexcessofpar( commonst ock) 88,
000

Sol
uti
on:
Asset
s
CurrentAsset s:
Cash $10,
000
Mar ketablesecuriti
es 20,
000
Account sreceivable $48,
000
Less: All
owancef orbad 6,
000 42,
000
debt s 66,
000
Inv entory $138,
000
TotalCurrentAssets
OtherAsset s: 20,
000
Inv estment s
Fi
xedAsst s: $680,
00
Pl antandequi pment 0
Less: Accumul ated 380,
000
depr eciati
on 300,
000 $538,
000
Netpl antandequi pment
Tot alAssets

S-
21
 Liabi li
tiesandSt ockhol
ders'Equi
ty
CurrentLi abi li
ties:
Account spay able $35,
000
Not espay able 33,
000
Total cur rentl i
abil
it
ies $68,
000
Long- t
er m Li abiliti
es
Bondspay abl e 136,
000
Total Liabi li
ti
es $204,
000
Stockhol der s' Equi t
y:
Pr eferredst ock, $50par,1,000shares
outstandi ng 50,
000
Commonst ock, $1par,100,000shares
outstandi ng 100,
000
Capi tal paidi nexcessofpar( common 88,
000
stock) 96,
000
Ret ainedear nings $334,
000
Total Stockhol ders'Equit
y $538,
000
Tot al Liabi l
iti
esandSt ockhol
ders'
Equity

S-
22
2-
15. LandersNurseryandGardenStoreshascurrentassetsof$220,
000and
fi
xedassetsof$170,000.Curr
entli
abili
ti
esare$80,000andlong-
term
l
iabi
li
ti
esare$140,000.Thereis$40,000inpref
erredstockout
standi
ng
andthefi
rm hasissued25,000sharesofcommonst ock.Computebook
val
ue(networ t
h)pershare.

Sol
uti
on:
Lander
sNur
ser
yandGar
denSt
ores

Currentassets $220,
000
Fixedasset s 170,
000
Totalassets $390,
000
– 80,
000
Currentli
abili
ti
es 140,
000
– 170,
000
Long-ter
ml iabil
it
ies 40,
000
Stockholders'equi
ty $130,
000
–
Preferr
edstockobl i
gati
on 25,
000
Networ thassignedtocommon
$5.
20
Commonshar
esout
standi
ng

Bookv
alue(
networ
th)pershar
e

S-
23
2-
16. AmigoSof t
ware, I
nc.hastotalassetsof$800,000,cur
rentl
i
abil
it
iesof
$150,000,
andl ong-t
ermliabil
i
tiesof$120,000.Therei
s$65,000in
pref
erredstockoutstandi
ng.Thi r
ty-
thousandsharesofcommonst ock
hasbeenissued.

a.Computebookv al
ues(networ th)pershare.
b.Ift
herei
s$48,000inearningsav ai
lablet
ocommonst ockholder
sand
thefi
rm'
sstockhasaP/ Eof20t imesearningspershare,whati
st he
curr
entpri
ceofthestock?
c.Whatistherat
ioofmar ketvaluepersharetobookv al
uepershar e?
(Roundtotwoplacestother i
ghtoft hedecimalpoi
nt.
)

Sol
uti
on:
Ami
goSof
twar
e,I
nc.

a. Totalassets $800,
000
– Currentli
abi
li
ti
es 150,
000
– Long-termli
abil
it
ies 120,
000
Stockholder
s'equi
ty $530,
000
– Preferr
edstock 65,
000
Networ thassi
gnedtocommon $465,
000

Commonshar
esout
standi
ng 30,
000

Bookv
alues(
networ
th)pershar
e $15.
50

b. Earni
ngsavail
abl
etocommon $48,
000
Sharesout
standi
ng 30,
000
Earni
ngspershar
e $1.
60

c. Marketv
aluepershar
e(pr
ice)t
obookv
alueper
shar
e
$32.
00/$15.
50=2.06

S-
24
S-
25
2-
17. I
npr
oblem 16,
ift
hef i
rm sel
l
sat2.5timesbookval
uepershar
e,whatwi
l
l
t
heP/Erat
iobe?(Roundtothenearestwhol
enumber.
)

Sol
uti
on:
Ami
goSof
twar
e,I
nc.(
cont
inued)

2-
18. ForDecember31,
2001,
thebal
ancesheetofBax
terCor
por
ati
oni
sas
fol
l
ows:

Curr
entAsset
s Liabi
li
ti
es
Cash $10,
000 Account
spay able $12,
000
Accountsrecei
vabl
e 15,
000 Notespayabl
e 20,
000
I
nv ent
ory 25,
000 Bondspayable 50,
000
Prepai
dexpenses 12,
000

Fi
xedAssets Stockholder
s'Equi
ty
Plantandequi pment(gr
oss) Commonst ock $75,000
$250,000 Pai
d-i
n-capital 25,
000
Less: Accumulat
ed Ret
ainedear ni
ngs 80,
000
Depreci
ati
on 50,
000
Netpl antandequipment Tot
alli
abi
l
iti
esand
200,000 St
ockhol
ders'
equi
ty $262,
000

Tot
alasset
s $262,
000

Salesfor2001wer e$220,000, andthecostofgoodssoldwas60per cent

ofsales.Sel
li
ngandadmi ni
strati
veexpensewas$22, 000.Depreciati
on
expensewas8per centofplantandequi pment(gr
oss)atthebegi nningof
theyear.I
nterestexpenseforthenot espayablewas10per cent
,and
i
nterestexpenseont hebondspay abl
ewas12per cent.Theseinterest
expensesarebasedonDecember31, 2000,bal
ances.Thetaxrate
averaged20per cent.

S-
26
 Twot housanddoll
arsinprefer
redst
ockdivi
dendwerepai
dand$8,
400in
di
videndswerepaidtocommonst ockhol
der
s.Ther
ewere10,
000shar
es
ofcommonst ockoutst
anding.

During2001,t
hecashbal anceandprepaidexpensesbalancewer e
unchanged.Account
sr eceiv
abl
eandi nventoryi
ncreasedby10per cent
.A
newmachi newaspurchasedonDecember31, 2001,atacostof$35,000.
Accountspayabl
eincreasedby25per cent.Notespayableincr
easedby
$6,000andbondspay abledecr
easedby$10, 000,bothattheendoft he
year.Thecommonst ockandpai d-
incapit
al i
nexcessofparaccount sdid
notchange.

a.Pr
epar
eani
ncomest atementfor2001.
b.Pr
epar
eastatementofret
ainedearni
ngsf
or2001.
c.Pr
epar
eabalancesheetasofDecember31,2001.

Sol
uti
on:
BaxterCor
porati
on
2001IncomeStatement
a.Sales $220, 000
Costofgoodsol d( 60%) 132, 000
Gr osspr ofit $88, 000
Sell
ingandadmi nistr
ati
v eexpense 22, 000
Depreci ati
onexpense( 8%) 20,0001
Oper atingpr ofit(EBIT) $46, 000
I
nterestexpense 8,0002
Ear ningsbef or etaxes $38, 000
Taxes( 20%) 7,600
Ear ningsaf tertaxes( EAT) $30, 400
Preferredst ockdi v i
dends 2,000
Earningsav ail
ablet ocommonst ockhol
der
$28,400
Sharesout standing 10, 000
Earningspershar e $2. 84

8%*$250,
1
000=$20,000
(
2
10%*$20,000)+(
12%*$50,
000)=$8,
000

S-
27
 b.2001St at
ementofRet ai
nedEar ni
ngs
Retai
nedear ningsbalance,January1,
2001$80,000
Add:Earningsav ail
ablet
ocommon
stockholders,
2001 28,
400
Deduct:Cashdi videnddeclar
edin2001 8, 400
Retai
nedear ningsbalance,
December31, 2001 $100,
000

2001Bal
anceSheet

CurrentAssets Li
abil
i
ties
Cash $10,
00 Account
spay abl
e $15,
000
0
Accounts 16,
500 Notespayabl
e 26,
000
r
eceivable
I
nventory 27,
500 Bondspayable 40,
000

Prepai
d _
___
___
expenses 12,
000
$66,
00 $81,
000
0

Fi
xedAsset
s Stockhol
der
s'Equi
ty
Gr
ossplant $285,
00 Commonstock $75,000
0

Accumul
ated Paidincapi
tal
in
depr (
70,
000)excessofpar 25,
000
3

Netpl
ant Ret
ainedear
nings 100,
000
215,
000

$50,
3
000+$20,
000=$70,
000

S-
28
 Tot
alasset
s $281,
00 Tot
alLi
abi
l
ity& $281,
000
0 Equit
y
2-
19. Prepareastat
ementofcashfl
owsfort
heJeterCorpor
ati
on.Fol
l
owt
he
generalpr
ocedur
esindi
catedi
nTabl
e2-10ofthechapter
.

JeterCor
porat
ion
IncomeStat
ement
Fort
heYearEndedDecember31,
2001

Sales $3,
300,
000
Costofgoodssol d 1,
950,
000
Gr osspr ofit
s 1,
350,
000
Sell
ingandadmi nistr
ativ
eexpense 650,
000
Depreci ati
onexpense 230,
000
Oper atingincome 470,
000
I
nterestexpense 80,
000
Ear ningsbef oretaxes 390,
000
Taxes 140,
000
Ear ningsaf t
ertaxes 250,
000
Preferredst ockdi vi
dends 10,
000
Earningsav ail
abletocommonst ockhol
der
s $ 240,
000
Sharesout standing 150,
000
Earningspershar e $1.
60

Stat
ementofRetai
nedEarni
ngs
FortheYearEndedDecember31,2001

Retainedear nings,
balance,
January1,2001 $800,
000
Add: Earningsavail
ablet
ocommonst ockhol
der
s,2001
240,000
Deduct :
Cashdi videndsdecl
aredandpaidin2001 140,
000
Retainedear nings,
balance,
December31, 2001 $900,
000

Compar
ati
veBalanceSheet s
For2000and2001
Year-End Year-End
2000 2001
Asset
s
Cur
rentassets:
Cash $ 100,
00 $ 120,
000
Accountsr ecei
vabl
e(net
) 0 510,
000
Invent
ory 500,
000 640,
000
Prepaidexpenses 610,
000 30,
000

S-
29
 Totalcurr
entasset
s 60,
000 1,
300,
000
Inv est
ment s(l
ong-t
erm securi
ti
es) 1,
270,
000 80,
000
Plantandequi pment 90,
000 2,
600,
000
Less: Accumulat
eddepr eci
ati
on 2,
000,
000 1,
230,
000
Netpl antandequipment 1,
370,
000
Tot
al assets 1,
000,
000 $2,
750,
000

1,
000,000
$2,
360,00
0
Li
abi
l
iti
esandSt
ockhol
der
s'Equit
y
Currentliabili
ties:
Account spay able $ 300,
00 $ 550,
000
Not espay able 0 500,
000
Accr uedexpenses 500,
000 50,
000
Total curr entliabil
iti
es 1,
100,
000
Long-terml i
abi li
ti
es: 70,
000
Bondspay abl e,2004 870,
000 160,
000
Total l
iabi li
ti
es 1,
126,
000
Stockhol ders' equi t
y :
Prefer r
edst ock, $100parv alue 100,
000 90,
000
Commonst ock, $1parv alue 970,
000 150,
000
Capi talpaidi nexcessofpar 350,
000
Retainedear nings 90,
000 900,
000
Total stockhol der s'equit
y 150,
000 1,
490,
000
Totalli
abi l
iti
esandst ockholders'equi
ty 350,
000 $2,
750,
000

800,
000

1,
390,000
$2,
360,00
0
(Thefol
l
owingquest
ionsappl
ytot
heJet
erCor
porati
on,aspr
esent
edi
n
Probl
em 19.
)

Sol
uti
on:
Jet
erCorpor
ati
on
St
atementofCashFlows
Fort
heYearEndedDecember31,2001

Cashflowsfr
om operat
ing
act
ivi
ties: $250,
000
Netincome(ear
ningsaft
er

S-
30
 t
axes)
Adj ustmentstodet ermi necash $230,000
flowf rom operatingactivit
ies: (
10,000)
Addbackdepr eciat
ion (
30,000)
Increaseinaccount sreceivable 30,000
Increaseini nventory 250,000
Decr easeinpr epaidexpenses (
20,000)
Increaseinaccount spay able $450,000
Decr easeinaccr uedexpenses
Totaladjustment s $700,
000
Netcashf l
owsf rom oper ati
ng
activit
ies
10,000
Cashf lowsf rom investi
ng (
600,000)
acti
v iti
es: (
590,000)
Decr easei ni nvestment s
Increasei nplantandequi pment
NetCashf lowsf r
om investi
ng 60,000
act iviti
es (10,000)
Cashf lowsf rom f i
nancing (140,000) ( 90,
000)
acti
v iti
es:
Increasei nbondspay able $20,000
Pref erredst ockdi vi
dendspaid
Commonst ockdi v
idendspaid
Netcashf lowsf rom fi
nancing
Neti ncr ease( decrease)incash
fl
ows
Thest udentshoul dobservethattheincreaseincash
fl
owsof$20, 000equal sthe$20,000changei nthecash
accountont hebal ancesheet.Thisindicatesthe
statementi scor rect.
2-
20. Descr
ibet
hegener
alrel
ati
onshi
pbetweenneti
ncomeandnetcashf
lows
fr
om oper
ati
ngact
ivi
ti
esfort
hefir
m.

S-
31
Sol
uti
on:

Cashf l
owsf rom operati
ngactivi
ti
esfarexceedsnet
i
ncome.Thi soccursprimari
lybecauseweaddback
depreciati
onof$230, 000andaccountspay abl
eincrease
by$250, 000.Thus,thereaderofthecashflowstatement
getsimpor t
antinsi
ght sastohowmuchcashf lowwas
developedf r
om dail
yoper at
ions.

S-
32
2-
21. Hasthebui
ldupinplantandequi
pmentbeenf
inancedi
nasat
isf
act
ory
manner?Br
iefl
ydiscuss.

Sol
uti
on:

Thebui ldupinpl antandequi pmentof$600, 000( gross)

and$370, 000( net)hasbeenf i
nanced, i
npar t
,byt he
l
ar geincreasei naccount spay able(250,000).Thisis
notav er ysatisfactorysit
uation.Short-t
erm sourcesof
fundscanal way sdr yup,whilefixedassetneedsar e
per manenti nnat ure.Thisfi
rm maywi shtoconsi der
mor elong- t
ermf i
nancing,suchasamor tgage,togo
alongwi thpr ofit
s,theincreaseinbondspay able,and
theadd- backofdepr eciati
on.

2-
22. Computethebookval
uepercommonshar
eforbot
h2000and2001f
or
theJet
erCorpor
ati
on.

Sol
uti
on:

Book
val
ue
Pershar
e

Book
value
Pershare
(2000)

Book
value
Pershare
(2001)

S-
33
2-
23. I
fthemarketv
alueofashareofcommonstockis3.1t
imesbookval
ue
f
or2001,
whatisthefi
rm'sP/Erat
iof
or2001?(Roundt
othenearest
whol
enumber.)

Sol
uti
on:

S-
34