Chapter 2

Suggested Questions and Answers

Q1) Penguin Pucks, Inc., has a current assets of $4,800, net fixed assets of $27,500, current
liabilities of $4,200, and long-term debt of $10,500. What is the value of shareholders equity
account for this firm?

To find owners equity, we must construct a balance sheet as follows:

Balance Sheet

CA $ 4,800 CL $ 4,200

NFA 27,500 LTD 10,500

OE ??

TA $32,300 TL & OE $32,300

We know that total liabilities and owners equity (TL & OE) must equal total assets of
$32,300. We also know that TL & OE is equal to current liabilities plus long-term debt
plus owners equity, so owners equity is:

OE = $32,300 10,500 4,200 = $17,600

NWC = CA CL = $4,800 4,200 = $600

Q2) Billys Exterminators, Inc., has a sales of $734,000, costs of $315,000, depereciation
expense of $48,000, interest expense of $35,000, and a tax rate of 35%. What is the net income
for this firm?

The income statement for the company is:

Income Statement

Sales $734,000

Costs 315,000

Depreciation 48,000

EBIT $371,000

Interest 35,000

EBT $336,000

Taxes (35%) 117,600

Net income $218,400

Q8) Chevelle, Inc., has sales of $39,500, costs of $18,400, depreciation expense of $1,900, and
interest expense pf $1,400. If the tax rate is 35%, what is the operating cash flows, or OCF?

To calculate OCF, we first need the income statement:

Income Statement

Sales $39,500

Costs 18,400

Depreciation 1,900

EBIT $19,200

Interest 1,400

Taxable income $17,800

Taxes (35%) 6,230

Net income $11,570

OCF = EBIT + Depreciation Taxes = $19,200 + 1,900 6,230 = $14,870

Q10) The 2010 balance sheet of Greystone, Inc., showed current assets of $3,120 and current
liabilities of $1,570. The 2011 balance sheet showed current assets of $3,460 and current
liabilities of $1,980. What was the companys 2011 change in net working capital, or NWC?

Change in NWC = NWCend NWCbeg

Change in NWC = (CAend CLend) (CAbeg CLbeg)

Change in NWC = ($3,460 1,980) ($3,120 1,570)

Change in NWC = $1,480 1,550 = $70

Q21) Zigs Industries had the following operating results for 2011: sales= $27,360; cost of goods
sold= $19,260; depreciation expense= $4,860; interest expense= $2,190; dividends paid= $1,560.
At the beginning of the year, net fixed assets were $16,380, current assets were $5,760, and
current liabilities were $3,240. At the end of the year, net fixed assets were $20,160, current
assets were $7,116, and the current liabilities were $3,780. The tax rate for 2011 was 34%

a) what is the net income for 2011?

b) What is the operating cash flow for 2011?
c) What is the cash flow from assets for 2011? Is this possible? Explain.

a.

Income Statement
Sales $27,360

Cost of goods sold 19,260

Depreciation 4,860

EBIT $ 3,240

Interest 2,190

Taxable income $ 1,050

Taxes (34%) 357

Net income $ 693

b. OCF = EBIT + Depreciation Taxes

= $3,240 + 4,860 357 = $7,743

c. Change in NWC = NWCend NWCbeg

= (CAend CLend) (CAbeg CLbeg)

= ($7,116 3,780) ($5,760 3,240)

= $3,336 2,520 = $816

Net capital spending = NFAend NFAbeg + Depreciation

= $20,160 16,380 + 4,860 = $8,640

CFA = OCF Change in NWC Net capital spending

= $7,743 816 8,640 = $1,713

The cash flow from assets can be positive or negative, since it represents whether the
firm raised funds or distributed funds on a net basis. In this problem, even though net
income and OCF are positive, the firm invested heavily in both fixed assets and net
working capital; it had to raise a net $1,713 in funds from its stockholders and
creditors to make these investments.
 Chapter 3

Suggested Questions and Answers

Q1) SDJ, Inc., has net working capital of $2,710, current liabilities of $3,950, and inventory of
$3,420. What is the current ratio? What is the quick ratio?

Using the formula for NWC, we get:

NWC = CA CL

CA = CL + NWC = $2,710 + 3,950 = $6,660

So, the current ratio is:

Current ratio = CA / CL = $6,660/$3,950 = 1.69 times

And the quick ratio is:

Quick ratio = (CA Inventory) / CL = ($6,660 3,420) / $3,950 = 0.82 times

Q2) Diamond Eyes, Inc., has sales of $18 million, total assets of $15.6 million, and total debt of
$6.3 million. If the profit margin is 8%, what is net income? What is ROA? What is ROE?

We need to find net income first. So:

Profit margin = Net income / Sales

Net income = Sales(Profit margin)

Net income = ($18,000,000)(0.08) = $1,440,000

ROA = Net income / TA = $1,440,000 / $15,600,000 = .0923, or 9.23%

To find ROE, we need to find total equity. Since TL & OE equals TA:

TA = TD + TE

TE = TA TD

TE = $15,600,000 6,300,000 = $9,300,000

ROE = Net income / TE = 1,440,000 / $9,300,000 = .1548, or 15.48%

Q7) If Roten Rooters, Inc., has an equity multiplier of 1.45, total asset turnover of 1.80, and a
profit margin of 5.5%, what is its ROE?

ROE = (PM)(TAT)(EM)

ROE = (.055)(1.80)(1.45) = .1436, or 14.36%

Q22) Firm A and B have debt-total asset ratios of 45% and 35% and returns on total assets of 9%
and 12%, respectively. Which firm has a greater return on equity?

The solution requires substituting two ratios into a third ratio. Rearranging D/TA:

Firm A Firm B

D / TA = .45 D / TA = .35

(TA E) / TA = .45 (TA E) / TA = .35

(TA / TA) (E / TA) = .45 (TA / TA) (E / TA) = .35

1 (E / TA) = .45 1 (E / TA) = .35

E / TA = .55 E / TA = .65

E = .55(TA) E = .65 (TA)

Rearranging ROA, we find:

NI / TA = .09 NI / TA = .12

NI = .09(TA) NI = .12(TA)

Since ROE = NI / E, we can substitute the above equations into the ROE formula, which
yields:

ROE = .09(TA) / .55(TA) = .09 / .55 = 16.36% ROE = .12(TA) / .65 (TA) = .12 / .65 =
18.46%