Earth’s Best Company has sales of $200,000, a net income of $15,000, and the following balance sheet:Cash $ 10,000Receivables 50,000 Inventories 150,000Net fixed assets 90,000 Total assets $300,000____________________________Accounts payable 30,000Other current liabilities 20,000Long-term debt 50,000Common equity 200,000Total liabilities and equity $300,000The company’s new owner thinks that inventories are excessive and can be lowered to the point where the current ratio is equal to the industry average, 2.5, without affecting either sales or net income. If inventories are sold off and not replaced so as to reduce the current ratio to 2.5, if the funds generated are used to reduce common equity (stock can be repurchased at book value), and if no other changes occur, by how much will the ROE change?Now suppose we wanted to take this problem and modify it for use on an exam—that is, to create a new problem that you have not seen to test your knowledge of this type of problem. How would your answer change if we made the following changes: (1) We doubled all of the dollar amounts? (2) We stated that the target current ratio was 3.0? (3) We said that the company had 10,000 shares of stock outstanding, and we asked how much the change in part (a) would increase EPS? (4) What would your answer to (3) be if we changed the original problem to state that the stock was selling for twice the book value, so common equity would not be reduced on a dollar-for-dollar basis? c. Explain how we could have set the problem up to have you focus on chang- ing accounts receivable, or fixed assets, or using the funds generated to retire debt (we would give you the interest rate on outstanding debt), or how the original problem could have stated that the company needed more invento- ries and it would finance them with new common equity or with new debt.

Note: As the question has more than 3 sub-parts, the first 3 subparts [1, 2(1), 2(2)] are answered.…

Answered: Earth’s Best Company has sales of…

Managerial Accounting: The Cornerstone of Business Decision-Making

7th Edition

ISBN:9781337115773

Author:Maryanne M. Mowen, Don R. Hansen, Dan L. Heitger

Publisher:Maryanne M. Mowen, Don R. Hansen, Dan L. Heitger

Chapter14: Statement Of Cash Flows

Section: Chapter Questions

Problem 53P: Balance sheets for Brierwold Corporation follow: Additional transactions were as follows: a....

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Earth’s Best Company has sales of $200,000, a net income of $15,000, and the following balance sheet:

Cash $ 10,000

Receivables 50,000

Inventories 150,000

Net fixed assets 90,000

Total assets $300,000

____________________________

Accounts payable 30,000

Other current liabilities 20,000

Long-term debt 50,000

Common equity 200,000

Total liabilities and equity $300,000

The company’s new owner thinks that inventories are excessive and can be lowered to the point where the current ratio is equal to the industry average, 2.5, without affecting either sales or net income. If inventories are sold off and not replaced so as to reduce the current ratio to 2.5, if the funds generated are used to reduce common equity (stock can be repurchased at book value), and if no other changes occur, by how much will the ROE change?
Now suppose we wanted to take this problem and modify it for use on an exam—that is, to create a new problem that you have not seen to test your knowledge of this type of problem. How would your answer change if we made the following changes: (1) We doubled all of the dollar amounts? (2) We stated that the target current ratio was 3.0? (3) We said that the company had 10,000 shares of stock outstanding, and we asked how much the change in part (a) would increase EPS? (4) What would your answer to (3) be if we changed the original problem to state that the stock was selling for twice the book value, so common equity would not be reduced on a dollar-for-dollar basis?

c. Explain how we could have set the problem up to have you focus on chang- ing accounts receivable, or fixed assets, or using the funds generated to retire debt (we would give you the interest rate on outstanding debt), or how the original problem could have stated that the company needed more invento- ries and it would finance them with new common equity or with new debt.

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