Problem 1: (17 marks)

a) (i) & (ii) (iii) (15 marks)

Current Ratio = Current Assets / Current Liabilities

2012 = $1,211.6 = 1.035 = 1.04

$1,170.5

2011= $1,304.6 = 0.867 = 0.87

$1,503
(ii) 2012: Metro’s current assets are 1.04 times their current liabilities
(iii) Current ratio increased from 2011 to 2012 due to a decrease in current liabilities,
specifically the current portion of debt was much higher in 2011.

Return on Assets = Net Earnings + (Interest expense x (1-tax rate)) / Average Assets

2012 = ($489.3 + ($46.4 x (1 - 0.26*) ) ) = 0.104 = 0.10

( ($5150.4 + $4827.1) / 2)

* Tax rate = income tax / earnings before income tax =$174.7/$664 = 0.26

2011= ($392.7 + ($41.5 x (1-0.28**) ) ) = 0.088 = 0.09

( ($4827.1 + $4695.2) / 2)

** Tax rate = income tax / earnings before income tax =$152.8/$545.5 = 0.28
NOTE: if students do not re-calculate the tax rate for 2011 but do everything else
correct in the ratio, do not deduct marks for 2011 ROA, but do not grant them a
mark for the **tax rate calculation of 2011

(ii) 2012: Metro is generating $0.10 in net earnings for every $1 investment by creditors
and shareholders.
(iii) ROA increased from 2011 to 2012 due to an increase in net earnings that was
greater in proportion than the increase in total assets.

Return on Equity = Net Earnings / Average Equity

2012 = $489.3 = 0.1979 = 0.20

(($2,545.1 + $2,399.3) / 2)

2011= $392.7 = 0.1664 = 0.17

( ($2,399.3 + $2318.9) / 2)
 (ii) 2012: Metro is generating $0.2 in net earnings from every $1 investment by
shareholders
(iii) ROE increased from 2011 to 2012 due to an increase in net earnings that was
greater in proportion than the increase in total shareholders’ equity.

Price/Earnings Ratio = Current market price per share / Earnings per share

2012 = $58.4 = 11.991 = 11.99

$4.87

2011 = $44.69 = 11.729 = 11.73

$3.81

(ii) 2012: Metro’s market price per share is 11.99 times its EPS, suggesting that the stock
market is predicting a good future for Metro (growth and increased profit)
(iii) Price/Earnings increased from 2011 to 2012 due to an increase in Metro’s share
price, that was greater in proportion than the increase in EPS;
o this was caused by: (any one of the following would be acceptable)
• An acquisition
• Increase in net earnings and sales
• Increased total assets

b) (2 marks)
Non-current Assets: Goodwill changed by $210.4, from $1,649.1 in 2011 to $1,859.5 in
2012

Non-current Liabilities: Debt changed by $317.7, from $656.2 in 2011 to $973.9 in 2012

The most likely reason for this change is because Metro acquired another business
through the issuance of debt.
 Problem 2: (35 marks)

PART A (16 marks)

1. (11 marks)

Ratio 2015 2014

Total Asset = Revenue $2,031,718 = 1.29 $2,008,480 = 1.24

Turnover Average Total Assets $1,573,4701 $1,622,8253

Net earnings +
Interest expense $76,629 + [17,627 x $75,524 + [16,759 x
Return on = (net of tax) (1–(24,790/101,419))] = 0.06 (1–(27,610/103,134))] = 0.05
Assets Average Total Assets $1,573,4701 $1,622,8253

Return on = Net earnings $76,629 = 0.13 $75,524 = 0.14

Equity Average $574,7542 $522,8304
Shareholders’ Equity
Price = Price $14.10 = 13.06 $17.90 = 16.73
Earnings Net earnings $1.08 $1.07

Financial ROE – ROA 0.13 – 0.057 = 0.07 0.14 – 0.054 = 0.09

Leverage %

1 3
($1,563,476 + $1,583,463) ÷ 2 ($1,682,174 + $1,563,476) ÷ 2
2 4
($549,105 + $600,402) ÷ 2 ($496,555 + $549,105) ÷ 2

2. (3 marks)

The return on assets had a slight increase from 2014 to 2015 due to the decrease in average
assets and increase in net earnings from 2014 to 2015.
The return on equity decreased slightly from 14% to 13%, caused primarily by an increase in
retained earnings (from net earnings).
Leon’s has a positive financial leverage percentage in both years (although it decreased from
2014 to 2015).
Total Asset Turnover increased from 2014 to 2015 due to an increase in revenue and a decrease
in average assets.
In addition to comparing the ratios over the two-year period, it would be useful to compare
Leon’s profitability to that of other companies in the same industry.
3. (2 marks)
The financial statements are highly relevant to my decision since they provide useful
information about the company’s profitability (operations and performance), cash flows,
assets and obligation (financial strength). Provided the future for the industry is relatively
stable, this information allows the forecast and prediction of the company’s future earnings,
obligations and survivability (going concern).

Additional information: an investor should examine the industry opportunities as well as

specific strengths and weaknesses of the company’s operations including the quality of its
management team. Such assessments are made by financial analysts on a periodic basis to
advise their clients whether they should buy shares in Leon’s or sell the shares they already
own, and I may want to seek the advice of a financial analyst before making my final
decision.

PART B (19 marks):

1. (3 marks)
The three elements of the statement of financial position that had the largest changes in their
carrying amounts, and the typical reasons for these changes are summarized below:
Statement of financial position
element Change Reasons for change

Cash and cash equivalents –$38,311 The account decreased because cash
outflows exceeded cash inflows during the
year, particularly after repaying loans and
borrowings.

Loans and borrowings –48,006 This decrease reflects payment of loans and
other borrowings during the year. And
transfer from long-term to short-term
liabilities

Retained earnings +48,128 This increase reflects essentially the

difference between net earnings reported
for 2015 and dividends declared to
shareholders.
 2. (6 marks)
Cash 98,000
Accumulated depreciation - Trucks 159,680
Trucks 200,000
Gain on sale of trucks 57,680

Depreciation, 2013 = $200,000 x [2/5 x ½] = $ 40,000

Depreciation, 2014 = ($200,000 – 40,000) x 2/5 = 64,000
Depreciation, 2015 = ($160,000 – 64,000) x 2/5 = 38,400
Depreciation, 2016 = ($96,000 – 38,400) x [2/5 x 9/12] = 17,280 – 9,680 = 6800*
Accumulated depreciation, September 30, 2016 $150,000
* Depreciation for 2016 is reduced to $6,800 to ensure that the carrying value of the
two trucks does not fall below their residual value of $50,000.
Gain on sale of trucks = $98,000 – ($200,000 – 150,000) = $48,000
Alternatively, the depreciation may be calculated for all 5 trucks and then take 2/5 of
these amounts. In this case, the depreciation amounts would be: $100,000 + 160,000 +
96,000 + 19,000 = $375,000 ==> 2/5 of this amount = $150,000.

3. (4 marks)
Common shares (100,000 x $0.47) 47,000
Retained earnings 1,363,000
Cash (100,000 x $14.10) 1,410,000

Average issue price per share = $34,389,000 / 73,168,000 = $0.47

4. (3 marks)
Retained earnings, beginning + Net earnings – Dividends declared = Retained earnings, end
$510,398 + 76,629 – Dividends declared = $558,526 ==> Dividends declared = $28,501
Dividends paid = Dividends declared – Increase in Dividends payable
= $28,501 – (7,141 – 7,105) = $28,465
5. (3 marks)
Deferred warranty plan revenue is reported twice in the statement of financial position because
the liability to be settled within one year as Current liability, and the amount to be settled after
one year from the date of the statement as Non-current liability.

Deferred warranty plan revenue, beginning $143,365 ($51,111 + 92,254)

+ Sale of new deferred warranty plans 63,785
– Warranty plan revenue X X = $61,995
Deferred warranty plan revenue, beginning $145,155 ($49,380 + 95,775)
Problem 3: (14 marks in total)

a. For showing the calculation correctly

2009 2010 2011
Return on Assets 32.04% 14.17% 17.78%
Calculations: Net income + interest Exp (net of tax) / Av. Total Assets
2009: [97,020 + (7,200 x 0.6)] / (120,000 + 60,800 + 303,700) 
= 0.3204 = 32.04%
2010: [56,100 + (13,200 x 0.6)] / {[(120,000 + 60,800 + 303,700) + (155,400 + 175,200
+ 408,600)]/2} = 0.1417 = 14.17%
2011: [108,000 + (28,500 x 0.6)] / {[(155,400 + 175,200 + 408,600) + (414,600 +
300,000 + 490,200)]/2} = 0.1778 = 17.78%

Debt/Equity 59.5% 80.9% 145.8%

Calculations: (Current Liabilities + Long-term) / Shareholders’ Equity
2009: (120,000+60,800) / 303,700 = 0.5953 = 59.53%
2010: (155,400 + 175,200) / 408,600 = 0.8091 = 80.91%
2011: (414,600 + 300,000) / 490,200 = 1.4578 = 145.78%

Times interest earned 23.46 7.84 7.32

Calculations: Net Income + Interest Exp. + Income Tax Exp. / interest exp
2009: (97,020 + 7,200 + 64,680) / 7,200 = 23.46
2010: (54,180 + 13,200 + 36,120) / 13,200 = 7.84
2011: (108,000 + 28,500 + 72,000) / 28,500 = 7.32

Quality of earnings 1.10 1.18 1.06

Calculations: Cash flows from Operating Activities / Net Income
2009: 106,300 / 97,020= 1.10
2010: 64,200 / 54,180 = 1.18
2011: 115,000 / 108,000 = 1.06

b.
The return on Assets ratio indicates how much income was generated from each dollar invested in
assets, i.e. how efficient management is in using assets.
• This has decreased significantly from 33.37% in 2009 to 17.44% in 2010 and the slightly
increasing to 27.84% in 2011.
• While this decrease is partly due to the significant increase in assets over the three years,
the decrease from 2009 to 2010 is magnified by the decrease in net income from 2009 to
2010 (and increase in interest expense).
The debt/equity ratio
• Has increased significantly over the three-year period.
• Both long-term and short-term debt have experienced substantial growth.
• Specifically, the debt/equity shows that creditors have lent $1.46 for every $1.00 of
shareholders' equity.
• The higher this ratio, the greater the risk to the lender because shareholders' equity acts as
a cushion when operating losses occur.
• This increase in debt could have been used to expand operations (acquisitions?) as assets
have increased by around $500,000 from 2009 to 2011.

The times-interest-earned ratio

• Has dropped dramatically,
o Indicating the decreasing likelihood that long-term lenders will receive their
interest payments when due if this ratio continues to decrease.
• Yet interest expense is still covered by net income by around 7 times in 2010 and 2011.

The Quality of Earnings:

• Is consistently above 1, this means that every dollar of net income is supported by $1 of
cash flows from operating activities.
• This means that accruals are not abused by the company to boost their net income,
indicating high quality earnings.

Overall:

While Balding Inc. does seem to have good quality earnings, and its return on assets seems to
have recovered from a drop in 2010, its times interest earned ratio is continuously decreasing and
its debt to equity ratio is extremely high (debt is not fully covered by the company’s equity)
The bank should not advance a loan at this time due to the substantial risks involved (the high
level of debt held compared to equity
OR
The bank should give the loan since Balding seems to be expanding its business and it has a good
ROA, high quality earnings and its interest expense is covered 7 times by net income