FIN320 problem set #2

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Fin 320: Green Practice Problems: II.B 1 1. Introduction and Overview 12 th edition From RWJ Chapter 1: Questions and Problems: 2, 7, 12 II.A Financial Statements and Analysis From RWJ Chapter 2: Questions and Problems 7, 11, 12, 19 Chapter 3: Questions and Problems 18, 23 Additional Problems 1. Using the information below, present the Income Statement and Balance Sheet for Lexon Enterprises. • Sales for the year were $2,500,000. • Gross Margin is 20%. • Selling and Administrative expenses are 4% of sales. • Depreciation expenses arise from the straight-line depreciation of equipment purchased three years ago for $1.5 million. The equipment has an expected life of ten years with no salvage value. • Lexon has outstanding debt of $900,000 on which it pays interest of 10%. • Lexon had cash of $40,000, inventory of $200,000, accounts receivable of $290,000, and accounts payable of $220,000 outstanding. • The current tax rate faced by the company is 20%. • The have been no changes in the ownership of the enterprise since 40,000 shares were originally issued two years ago at a price of $7.50 each. As of year-end last year, the enterprise had retained earnings of $32,000. 2. Using the statements you prepared for Lexon Enterprises in Problem (1), perform the analysis listed below. a) Calculate the following ratios: current and quick ratios; inventory turnover and days’ sales in Receivables; fixed and total asset turnover; debt ratio; profit margin, ROA, ROE. b) Write out the relationships that comprise the extended Du Pont equation. Comment on your results given that Lexon Enterprises competes against Bluffard Enterprises and you have obtained the following data: ROE of 16%, PM of 6.9%, ratio of total assets to equity of 1.2. 3. The owner of a hardware company has asked you to take a look at their financials and provide advice. a) They supplied you with financial statements for the past three years and some financial statement ratios calculated by their accountant. Unfortunately, they ran out of time and didn’t get the ratios finished. Compute the missing ratios (all sales are on credit.)

Fin 320: Green Practice Problems: II.B 2 Income Statement 2020 2021 2022 Total Sales 1,237,000 1,375,000 1,520,000 Cost of Goods Sold 990,000 1,111,000 1,278,000 Selling, Gen & Admin 108,000 128,000 146,000 Total Operating Expenses 1,098,000 1,239,000 1,424,000 Operating Income 139,000 136,000 96,000 Interest Income (Expense) (31,000) (46,000) (56,000) Income before taxes 108,000 90,000 40,000 Income taxes 54,000 45,000 20,000 Net Income 54,000 45,000 20,000 Balance Sheet 2020 2021 2022 Cash 27,000 25,000 26,000 Accounts Receivable 155,000 302,000 380,000 Inventory 310,000 335,000 377,000 Total Current Assets 492,000 662,000 783,000 Property, Plant & Equipment 210,000 245,000 260,000 Total Assets 702,000 907,000 1,043,000 Accounts Payable 2020 2021 2022 Accrued Liabilities 43,000 54,000 61,000 Note Payable to Bank 70,000 114,000 194,000 Current Portion of Long-Term Debt 23,000 20,000 19,000 Total Current Liabilities 236,000 301,000 397,000 Long Term Debt 230,000 325,000 345,000 Owners’ Equity 236,000 281,000 301,000 Total Liabilities and Equity 702,000 907,000 1,043,000 Selected Ratios 2020 2021 2022 Current Ratio 2.08 2.20 Quick Ratio 1.09 1.02 Average collection period 80.17 91.25 Fixed asset turnover 5.61 5.85 Total asset turnover 1.52 1.46 Times interest earned 4.48 1.71 ROE 22.9% 16.0% 6.6% b) How well is the firm performing financially? Using their financial ratios, comment on the trends in the company’s liquidity, leverage and profitability.

Fin 320: Green Practice Problems: II.B 3 4. In response to complaints about high prices, a grocery store chain runs the following advertising campaign: “If you pay your child 75 cents to go buy $25 dollars of groceries, then your child makes twice as much on the trip as we do”. You’ve collected the following information from the grocery chain’s financial statements: • Sales: $225 million • Net income: $3.375 million • Total Assets: $40 million • Total debt: $17 million Evaluate the grocery chain’s claim. What is the basis or the statement? Is this claim misleading? Why or why not?

Fin 320: Green Practice Problems: II.B 4 II.B Financial Statements and Analysis: (Pro Formas) From RWJ Chapter 4: Questions and Problems 19, 21, 24 Additional Problems 1. The most recent financial statements for Surfing Supply Corp. are given below. Using the financial statements and the following information, create pro forma statements for next year and in doing so, calculate the total additional external financing needed (identifying all sources of funds and their respective amounts of funding). Show all calculations used to arrive at your answer. • Sales are projected to grow by 50% next year. • Assume that all costs, assets, and current liabilities will vary directly with sales. • Also assume that the firm intends to keep its dividend payout ratio constant and that the firm’s tax rate will remain 34%. • The current debtholders have placed a restriction on the firm that prohibits long- term debt from exceeding 40% of total assets. • The managers of the firm wish to utilize long-term debt as much as possible as a source of financing, and then common stock as needed. The interest rate on long- term debt for next year is 10%. This Year’s Income Statement Balance Sheet for this year Sales 1500 Cash 50 Cost of Goods Sold 750 Accounts Receivable 300 General/Admin. Expenses 250 Inventory 500 Depreciation Expense 200 Net Fixed Assets 500 EBIT 300 Total Assets 1350 Interest Expense 40 EBT 260 Accounts Payable 250 Taxes (34%) 88.40 Long-term debt 400 Net Income 171.60 Com. Stock & Paid-in Capital 500 Dividends 57.20 Retained Earnings 200 Addition to Retained Earnings 114.40 Total Liab. & Owners’ Equity 1350

Fin 320: Green Practice Problems: II.B 5 2. The most recent balance sheet and income statement for Popart Inc. are given below. Prepare pro forma financial statements for the next year and calculate the amount of additional long- term borrowing that would be necessary to fund the firm’s projected growth. • Sales are projected to grow by 20% next year. • Costs are expected to grow with sales. However, depreciation expense will not change next year. • Cash, inventories, accounts payable, and PP&E also vary with sales. The value of land will remain constant in the coming year. • The firm plans to enforce a collection policy that will keep Days’ Sales in Receivables ratio at 30 days. • The company intends to keep its dividend payout ratio constant. • The company’s creditors require it to maintain a Current Ratio of at least 1.80. • The company prefers to use as much short-term debt (Notes Payable) as possible. If short- term debt capacity is not sufficient, it will raise the additional needed funds through long-term borrowing (Long-term Debt). The interest rate applicable to both short and long-term debt is 10%. • The firm’s tax rate is 40%. This year’s Balance Sheet Cash $9,000 Accounts Payable $10,000 Accounts Receivable $12,000 Notes Payable $17,000 Inventories $29,000 Tot. Current Liab. $27,000 Tot. Current Assets $50,000 Long-term Debt $30,000 Land $20,000 Net Plant, Property & Eqpmt $42,000 Common Stock $31,000 Total Fixed Assets $62,000 Retained Earnings $24,000 Total Assets $112,000 Tot. Liab. & Equity $112,000 Annual Income Statement for this year Sales $125,000 Cost of Goods Sold $75,000 Gross Margin $50,000 Selling Expense $21,000 Gen.& Adm. Expense $12,500 Depreciation Expense $4,500 EBIT $12,000 Interest Expense $4,700 EBT $7,300 Taxes $2,920 Net Income $4,380 Dividends $1,752 R / E $2,628

Fin 320: Green Practice Problems: II.B 6 3. The financial statements for The English Leather Company are reproduced below. You are given the following information about the coming year. Prepare Pro Forma statements for the company for next year. • Sales are expected to increase by 10% and COGS will be 65% of sales • GA&S will remain at the same level and the cash level will remain the same. • Depreciation expense will be $91,000 and the company will add $170,000 of new assets and dispose of (sell) assets with book values of $30,000. The selling price of the sold assets will be equal to book value and therefore, there will be no tax effects. • The tax rate will be 40% • The company paid $500,000 in dividends in 2010 and will pay the same dividend next year. • AR will be reduced to 35 days’ worth of sales. Inventory management improvements will reduce inventories to 55 days of COGS. Accounts payable will remain at 30 days of COGS. The company uses a 360 day year in its calculations. • Accruals will be 1% of sales • The company is not allowed to borrow any more by way of long-term debt. Instead, any additional borrowing will come out of notes payable. The interest rate on long-term debt is 8%, while the interest rate on notes payable is 10%. Balance Sheets (in $000s) Income Statement Today Today Assets Cash 100 Sales 2200 Accounts receivable 275 Cost of goods sold 1452 Inventories 242 Gross margin 748 Total Current Assets 617 GA&S 470 Depreciation expense 83 Gross Fixed Assets 1200 Earnings before interest 195 Less: Acc. Depreciation 525 and taxes (EBIT) Net Fixed Assets 675 Interest expense 60 Earnings before taxes 135 Total Assets 1292 Taxes (40%) 54 Net income 81 Liabilities & Owners' Equity Accounts Payable 121 Notes Payable 100 Accruals 22 Total Current Liabilities Long-term Debt (8%) 625 Common Stock 120 Retained Earnings 304 Total Equity 424 Total Liabilities & Equity 1292

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