SM Ch3-6
SM Ch3-6
SM Ch3-6
Solutions Manual
Chapter 3
BASIC
12.
Building a Statement of Financial Position [LO1] Cable &
Wireless plc has current assets of 1.541 billion, non-current assets
of 3.650 billion, current liabilities of 1.856 billion, and non-current
liabilities of 1.291 billion. What is the value of the shareholders
equity account for this firm? How much is net working capital?
Answer: To find owners equity, we must construct a statement of
financial position as follows:
Liabilities &
Owners'
Equity
in
billion
1.541
Current assets
Non-current assets
3.65
in billion
Current
liabilities
Non-current
liabilities
Owners' equity
5.19
1
Owners' equity
Current assets
Current liabilities
Net working
capital
2.044
in
billion
1.541
1.856
-0.315
13.
Building an Income Statement [LO1]Johnson Matthey
plc has revenues of 7.848 billion, costs of 7.324 billion,
depreciation expense of 108.9 million, interest expense of 42.7
million, and a tax rate of 28 per cent. What is the net income for
this firm?
Answer:
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1.856
1.291
x
5.191
Revenues
Costs
0.524
0.0427
0.1089
Gross Profit
Interest Expense
Depreciation
Taxable Income
Tax (28%)
0.3724
0.104272
0.268128
Net Income
14.
Calculating Liquidity Ratios [LO2]Essilor International SA
has current assets of 2,826 million, current liabilities of 1,875
million, and inventory of 833 million. What is the current ratio?
What is the quick ratio?
Answer: The relevant formulae are:
Current ratio =
Quick ratio =
Current assets
Current liabilities
Current Ratio =
Quick Ratio =
2,826
1.51
1,875
2,826 833
1.06
1,875
15.
Calculating Profitability Ratios [LO2]Volkswagen AG had
sales of 113,808 million, total assets of 167,919 million, and total
debt of 69,380 million. If the profit margin is 4.173 per cent, what
was net income? What was ROA? What was ROE?
Answer: We need to find net income first. So:
Profit margin = Net income / Sales
Net income = Sales(Profit margin)
Net income = (113,808)(0.04173) = 4,749.2
ROA = Net income / TA = 4749.2 / 167,919 = .0282 or 2.82%
To find ROE, we need to find total equity. Since TL & TE equals TA:
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TA = TD + TE
TE = TA TD
TE = 167,919 69,380 = 98,539
ROE = Net income / TE = 4,749.2 / 98,539 = .0482 or 4.82%
16.
Calculating Leverage Ratios [LO2]GNR plc has a total
debt ratio of 0.43. What is its debtequity ratio? What is its equity
multiplier?
Answer: Total debt ratio = 0.43 = TD / TA
Substituting total debt plus total equity for total assets, we get:
0.43 = TD / (TD + TE)
Solving this equation yields:
0.43(TE) = 0.57(TD)
Debt/equity ratio = TD / TE = 0.43 / 0.57 = 0.75
Equity multiplier = 1 + D/E = 1 + 0.75 = 1.75
17.
Calculating Market Value Ratios [LO2]Axel plc had
additions to retained earnings for the year just ended of 430,000.
The firm paid out 175,000 in cash dividends, and it has ending
total equity of 5.3 million. If the company currently has 210,000
shares of equity outstanding, what are earnings per share?
Dividends per share? Book value per share? If the equity currently
sells for 63 per share, what is the market-to-book ratio? The price
earnings ratio? If the company had sales of 4.5 million, what is the
pricesales ratio?
Answer:
Net income
= 430,000 + 175,000 = 605,000
= Addition to RE + Dividends
= Dividends / Shares =
= TE / Shares
= 5,300,000 /
= 63 /
= Sales / Shares
4,500,000
P/S ratio
times
210,000
= 63 / 21.43 = 2.94
INTERMEDIATE
18.
Book Values versus Market Values [LO1]In preparing a
balance sheet, why do you think International Accounting Standards
allow both historical cost and fair value approaches?
Answer: Historical costs can be objectively and precisely measured
whereas market values can be difficult to estimate, and different
analysts would come up with different numbers. Thus, there is a
tradeoff between relevance (market values) and objectivity (book
values).
19.
Residual Claims [LO1]Moneyback Limited is obligated to
pay its creditors 7,300 during the year.
(a)
What is the market value of the shareholders equity if assets
have a market value of 8,400?
(b)
What if assets equal 6,700?
Answer: The market value of shareholders equity cannot be
negative. A negative market value in this case would imply that the
company would pay you to own the equity. The market value of
shareholders equity can be stated as: Shareholders equity = Max
[(TA TL), 0]. So, if TA is 8,400, equity is equal to 1,100, and if TA
is 6,700, equity is equal to 0. We should note here that the book
value of shareholders equity can be negative.
20.
Net Income and OCF [LO1]This year, Southern Coat
Company had sales of 730,000. Cost of goods sold, administrative
and selling expenses, and depreciation expenses were 580,000,
105,000 and 135,000 respectively. In addition, the company had
an interest expense of 75,000 and a tax rate of 28 per cent.
(Ignore any tax loss carry-back or carry-forward provisions.)
(a) What is Southern Coat Companys net income?
(b) What is its operating cash flow?
(c) Explain your results in (a) and (b).
Answer:
Income Statement
Sales
730,000
COGS
580,000
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a.
Assets
2012 2013
2012
2013
Current assets
653
707
Current liabilities
261
293
Non-current
assets
2,69
1
3,240
Non-current
liabilities
1,422
1,512
Parrothead Enterprises
2013 Income statement
Sales
8,280
Costs
3,861
Depreciation
Interest paid
738
211
b. NWC 2012
= CA12 CL12 = 653 261 = 392
NWC 2013
= CA13 CL13 = 707 293 = 414
Change in NWC = NWC12 NWC13 = 414 392 = 22
c. We can calculate cash flow from investing activities as:
Cash flow from investing activities = Non-Current Assets 2013 Non
Current
Assets 2012 + Depreciation
Cash flow from investing activities = 3,240 2,691 + 738 = 1,287
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So, the company had a cash flow from investing activities of 1,287.
We also know that cash flow from investing activities is:
Cash flow from investing activities = Non-current assets bought Noncurrent assets sold
1,287 = 1,350 Non-current assets sold
Non-current assets sold = 1,350 1,287 = 63
d. Net new borrowing = NCL13 NCL12 = 1,512 1,422 = 90
Cash flow from financing activities = New borrowing - Interest = 90 211 = -121
Net new borrowing = 90 = Debt issued Debt retired
Debt retired
= 270 90 = 180
23.
Profit Margin [LO2]In response to complaints about high
prices, a grocery chain runs the following advertising campaign: If
you pay your child 3 to go and buy 50 worth of groceries, then
your child makes twice as much on the trip as we do. Youve
collected the following information from the grocery chains
financial statements:
(millions)
Sales
750
Net income
22.5
Total assets
420
Total debt
280
Evaluate the grocery chains claim. What is the basis for the
statement? Is this claim misleading? Why or why not?
Answer:
Child: Profit margin = NI / S = 3.00 / 50
Store: Profit margin
750,000,000
= 0.06 or 6%
= NI / S
= 0.03 or 3%
22,500,000
CHALLENGE
Some recent financial statements for the luxury goods company LVMH
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Revenue
Cost of revenue
Gross profit
Selling/general/admin. expenses
Amortization
Unusual expense (income)
Other operating expenses, total
Operating profit
Interest expense
Interest/invest income
Y/E
2013
Y/E
2012
17,193
16,481
6,012
5,786
11,181
10,695
7,553
7,140
126
116
17
3,485
3,429
255
241
15
30
41
Other, net
Profit before taxes
Provision for income taxes
Profit after taxes
Minority interest
Equity in affiliates
41
3,204
3,177
893
853
2,311
2,324
292
306
Profit attributable to
shareholders
2,026
2,025
Dec
12
m
Dec
13
m
Dec
12
m
Current liabilities
1,013
2,292
2,095
Trade receivables
1,650
1,866
1,552
229
1,571
2,212
Receivables
other
Total inventory
5,767
Other current
assets
1,695
Other current
2,001 liabilities
Total current
assets
10,3
54
Non-current
assets
276
926
610
628
6,615
7,413
Non-current
liabilities
Property/plant/
equipment
6,081
3,738
2,477
Goodwill, net
4,423
3,113
2,843
Intangibles, net
8,523
989
938
Long-term
investments
591
Other long-term
assets
1,51
1
12,06 11,38
4
1
21,1
29
18,67 18,79
9
4
4,224
5,123
Shareholders
equity
Ordinary shares
147
147
Additional paid-in
capital
1,737
1,736
Retained earnings
(accumulated
deficit)
12,274
11,19
2
983
877
Treasury stock
common
_____
Total assets
31,4
83
371
608
Total equity
12,80 11,59
4
0
31,48 30,38
3
4
24.
Calculating Financial Ratios [LO2]Find the following
financial ratios for LVMH Moet Hennessy Louis Vuitton SA (use yearend figures rather than average values where appropriate):
Short-term solvency ratios:
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________________________
________________________
________________________
________________________
________________________
________________________
________________________
________________________
________________________
________________________
________________________
________________________
Return
on
equity
________________________
Answer:
Short-term solvency ratios:
Current ratio
= Current assets / Current liabilities
Current ratio 2013
= 10,354m / 6,615m = 1.57 times
Current ratio 2012
= 10,118m / 7,413m = 1.36 times
Quick ratio
Quick ratio 2013
times
Quick ratio 2012
times
Cash ratio
Cash ratio 2013
Cash ratio 2012
Equity multiplier
Equity multiplier 2013
Equity multiplier 2012
= 1 + D/E
= 1 + 1.46 = 2.46
= 1 + 1.62 = 2.62
Return on assets
Return on assets 2013
Return on assets 2012
Return on equity
Return on equity 2013
Return on equity 2012
25.
Du Pont Identity [LO2]Construct the Du Pont identity for
LVMH Moet Hennessy Louis Vuitton SA.
Answer: The DuPont identity is:
ROE = (PM)(TAT)(EM)
ROE = (0.1178)(0.55)(2.46) = 0.1582 or 15.82%
26.
Market Value Ratios [LO2]LVMH Moet Hennessy Louis
Vuitton SA has 473.06 million ordinary shares outstanding, and the
market price for a share of equity at the end of 2012 was 46.79.
What is the priceearnings ratio? What is the market-to-book ratio
at the end of 2012? If the companys growth rate is 9 per cent, what
is the PEG ratio?
Answer:
Earnings per share
Earnings per share
P/E ratio
P/E ratio
Book value per share
Book value per share
Market-to-book ratio
= Share price / Book value per share
Market-to-book ratio = 46.79 / 27.06 = 1.73 times
PEG ratio
PEG ratio
27.
Tobins Q [LO2]What is Tobins Q for LVMH Moet Hennessy
Louis Vuitton SA? What assumptions are you making about the
book value of debt and the market value of debt? What about the
book value of assets and the market value of assets? Are these
assumptions realistic? Why or why not? Assume that the book value
of debt is equal to the market value of debt and the assets can be
replaced at the current value on the statement of financial position
(balance sheet).
Answer: First, we will find the market value of the companys equity,
which is:
Market value of equity = Shares Share price
Market value of equity = 473.06m (46.79) = 22,134.48m
The total book value of the companys debt is:
Total debt = Current liabilities + Non-Current Liabilities
Total debt = 18,679m
Now we can calculate Tobins Q, which is:
Tobins Q = (Market value of equity + Book value of debt) / Book value
of assets
Tobins Q = (22,134.48m + 18,679m) / 31,483m
Tobins Q = 1.30
Using the book value of debt implicitly assumes that the book value of
debt is equal to the market value of debt. This will be discussed in
more detail in later chapters, but this assumption is generally true.
Using the book value of assets assumes that the assets can be
replaced at the current value on the statement of financial position
(balance sheet). There are several reasons this assumption could be
flawed. First, inflation during the life of the assets can cause the book
value of the assets to understate the market value of the assets. Since
assets are recorded at cost when purchased, inflation means that it is
more expensive to replace the assets. Second, improvements in
technology could mean that the assets could be replaced with more
productive, and possibly cheaper, assets. If this is true, the book value
can overstate the market value of the assets. Finally, the book value of
assets may not accurately represent the market value of the assets
because of depreciation. Depreciation is done according to some
schedule, generally reducing balance or straight-line. Thus, the book
value and market value can often diverge.
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28.
Earnings Management [LO1]Companies often try to keep
accounting earnings growing at a relatively steady pace, thereby
avoiding large swings in earnings from period to period. They also
try to meet earnings targets. To do so, they use a variety of tactics.
The simplest way is to control the timing of accounting revenues
and costs, which all firms can do to at least some extent. For
example, if earnings are looking too low this year, then some
accounting costs can be deferred until next year. This practice is
called earnings management. It is common, and it raises a lot of
questions. Why do firms do it? Why are firms even allowed to do it
under International Accounting Standards? Is it ethical? What are
the implications for cash flow and shareholder wealth?
Answer: In general, it appears that investors prefer companies that
have a steady earnings stream. If true, this encourages companies
to manage earnings. Under International Accounting Standards,
there are numerous choices for the way a company reports its
financial statements. Although not the reason for the choices under
IAS, one outcome is the ability of a company to manage earnings,
which is not an ethical decision. Even though earnings and cash
flow are often related, earnings management should have little
effect on cash flow (except for tax implications). If the market is
fooled and prefers steady earnings, shareholder wealth can be
increased, at least temporarily. However, given the questionable
ethics of this practice, the company (and shareholders) will lose
value if the practice is discovered.
29.
Cash Flow [LO1]What are some of the actions that a small
company like The Grandmother Calendar Company (see Questions
6 to 10) can take if it finds itself in a situation in which growth in
sales outstrips production capacity and available financial
resources? What other options (besides expansion of capacity) are
available to a company when orders exceed capacity?
Answer:
Demanding
cash
up
front,
increasing
prices,
subcontracting production, and improving financial resources via
new owners or new sources of credit are some of the options. When
orders exceed capacity, price increases may be especially
beneficial.
30.
Non-Current Assets and Depreciation [LO1]On the
simplified statement of financial position, the non-current assets
(NCA) account is equal to the gross property, plant and equipment
(PPE) account (which records the acquisition cost of property, plant
and equipment) minus the accumulated depreciation (AD) account
(which records the total depreciation taken by the firm against its
property, plant and equipment). Using the fact that NCA = PPE
AD, show that the expression for net capital spending, NCA end
NCAbeg + D (where D is the depreciation expense during the year),
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