ANSWERS OF ASSIGNMENT 1

P3-2. Financial statement account identification

LG 1; Basic

(a) (b)
Account Name Statement Type of Account
Accounts payable BS CL
Accounts receivable BS CA
Accruals BS CL
Accumulated depreciation BS FA*
Administrative expense IS E
Buildings BS FA
Cash BS CA
Common stock (at par) BS SE
Cost of goods sold IS E
Depreciation IS E
Equipment BS FA
General expense IS E
Interest expense IS E
Inventories BS CA
Land BS FA
Long-term debt BS LTD
Machinery BS FA
Marketable securities BS CA
Notes payable BS CL
Operating expense IS E
Paid-in capital in excess of par BS SE
Preferred stock BS SE
Preferred stock dividends IS E
Retained earnings BS SE
Sales revenue IS R
Selling expense IS E
Taxes IS E
Vehicles BS FA
*
This is really not a fixed asset, but a charge against a fixed asset, better known as a contra-asset.
P3-6. Income statement preparation
LG 1; Intermediate
Owen Davis Company
Balance Sheet
December 31, 2012
Assets
Current assets:
Cash $ 215,000
Marketable securities 75,000
Accounts receivable 450,000
Inventories 375,000
Total current assets $1,115,000
Gross fixed assets
Land and buildings $ 325,000
Machinery and equipment 560,000
Furniture and fixtures 170,000
Vehicles 25,000
Total gross fixed assets $1,080,000
Less: Accumulated depreciation 265,000
Net fixed assets $ 815,000
Total assets $1,930,000
 Liabilities and stockholders’ equity
Current liabilities:
Accounts payable $ 220,000
Notes payable 475,000
Accruals 55,000
Total current liabilities $ 750,000
Long-term debt 420,000
Total liabilities $1,170,000
Stockholders’ equity
Preferred stock $ 100,000
Common stock (at par) 90,000
Paid-in capital in excess of par 360,000
Retained earnings 210,000
Total stockholders’ equity $ 760,000
Total liabilities and stockholders’ equity $1,930,000

P3-17. Interpreting liquidity and activity ratios

LG 3; Intermediate
a. Bluegrass appears to be holding excess inventory relative to the industry. This fact is
supported by the low inventory turnover and the low quick ratio, even though the current
ratio is above the industry average. This excess inventory could be due to slow sales
relative to production or possibly from carrying obsolete inventory.
b. The accounts receivable of Bluegrass appears to be high due to the large number of days
of sales outstanding (73 vs. the industry average of 52 days). An important question for
internal management is whether the company’s credit policy is too lenient or customers are
just paying slowly—or potentially not paying at all.
c. Since the firm is paying its accounts payable in 31 days vs. the industry norm of 40 days,
Bluegrass may not be taking full advantage of credit terms extended to them by their
suppliers. By having the receivables collection period over twice as long as the payables
payment period, the firm is financing a significant amount of current assets, possibly from
long-term sources.
d. The desire is that management will be able to curtail the level of inventory either by
reducing production or encouraging additional sales through a stronger sales program or
discounts. If the inventory is obsolete, then it must be written off to gain the income tax
benefit. The firm must also push to try to get their customers to pay earlier. Payment
timing can be increased by shortening credit terms or providing a discount for earlier
payment. Slowing down the payment of accounts payable would also reduce financing
costs.
Carrying out these recommendations may be difficult because of the potential loss of
customers due to stricter credit terms. The firm would also not want to increase their costs
of purchases by delaying payment beyond any discount period given by their suppliers
P3-23. Cross-sectional ratio analysis
LG 6; Intermediate
a.

Fox Manufacturing Company

Ratio Analysis
Industry Average Actual
2015 2015
Current ratio 2.35 1.84
Quick ratio 0.87 0.75
Inventory turnover 4.55 times 5.61 times
Average collection period 35.8 days 20.7 days
Total asset turnover 1.09 1.47
Debt ratio 0.30 0.55
Times interest earned 12.3 8.0
Gross profit margin 0.202 0.233
Operating profit margin 0.135 0.133
Net profit margin 0.091 0.072
Return on total assets 0.099 0.105
Return on common equity 0.167 0.234
Earnings per share $3.10 $2.15

Liquidity: The current and quick ratios show a weaker position relative to the industry
average.
Activity: All activity ratios indicate a faster turnover of assets compared to the industry.
Further analysis is necessary to determine whether the firm is in a weaker or stronger
position than the industry. A higher inventory turnover ratio may indicate low inventory,
resulting in stockouts and lost sales. A shorter average collection period may indicate
extremely efficient receivables management, an overly zealous credit department, or credit
terms that prohibit growth in sales.
Debt: The firm uses more debt than the average firm, resulting in higher interest
obligations that could reduce its ability to meet other financial obligations.
Profitability: The firm has a higher gross profit margin than the industry, indicating
either a higher sales price or a lower cost of goods sold. The operating profit margin is in
line with the industry, but the net profit margin is lower than industry, an indication that
expenses other than cost of goods sold are higher than the industry. Most likely, the
damaging factor is high interest expenses due to a greater than average amount of debt. The
increased leverage, however, magnifies the return the owners receive, as evidenced by the
superior ROE.
b. Fox Manufacturing Company needs improvement in its liquidity ratios and possibly a
reduction in its total liabilities. The firm is leveraged more highly than the average firm in
its industry and therefore has more financial risk. The profitability of the firm is lower
than average but is enhanced by the use of debt in the capital structure, resulting in a
superior ROE.

ANSWERS OF ASSIGNMENT 2

P4-5. Classifying inflows and outflows of cash

LG 2; Basic

Change Change
 Item ($) I/O Item ($) I/O
Cash 150 O Accounts receivable 460 I
Accounts 1,100 I Net profits 380 I
payable
Notes payable 530 O Depreciation 110 I
Long-term debt 1,890 O Repurchase of stock 475 O
Inventory 160 I Cash dividends 540 O
Fixed assets 550 O Sale of stock 950 I

Note 1: Think of cash in terms of money in a checking account.

Note 2: As a non-cash charge depreciation is not really an I/O at all, but it will be reported as
a positive amount on the statement of cash flows.

P4-6. Finding operating and free cash flows

LG 2; Intermediate
a. NOPAT  EBIT  (1  t)
NOPAT  $2,900  (1  0.40)  $1,740
b. OCF  NOPAT  depreciation
OCF  $1,740  $1,600
OCF  $3,340
c. FCF  OCF  net fixed asset investment*  net current asset investment**
FCF  $3,340  $1,400  $1,400
FCF  $540
* Net fixed asset investment  change in net fixed assets  depreciation
Net fixed asset investment  ($14,600  $14,800)  ($16,300  $14,700)
Net fixed asset investment  –$200  $1,600  $1,400
** Net current asset investment  change in current assets  change in
(accounts payable and accruals)
Net current asset investment  ($9,600  $8,200)  ($100  $100)
Net current asset investment  $1,400  0  $1,400
d. Summer Breeze Corporation has positive cash flows from operating activities.
Depreciation is approximately the same size as net operating profit after tax, so the
operating cash flow is about twice the NOPAT. The FCF value is very meaningful since it
shows that the cash flows from operations are adequate to cover both operating expense
plus investment in fixed and current assets.
P4-9. Cash budget—basic
LG 4; Intermediate

June July August Sept. Oct. Nov

Sales 350,000 380,000 390,000 385,000 418,000 429,000
Cash sales (0.30) 105,000 114,000 117,000 115,500 125,400 128,700
Lag 1 month (0.65) 227,500 247,000 253,500 250,250 271,700
Other income 3,000 3,000 3,000
Total cash receipts 372,000 378,650 403,400
Disbursements
Purchases 120,000 150,000 120,000 115,000
Cash purchases(0.5) 75,000 60,000 57,500
Lag 1 month (0.5) 60,000 75,000 60,000
Rent 3,500 3,500 3,500
Wages & salaries 46,800 46,200 50,160
Dividends 4,600
Principal & interest 4,700
Purchase of new 8,500
equipment
Taxes due 8,250
Total cash 189,900 189,400 187,910
disbursements

Total cash receipts 372,000 378,650 403,400

Total cash 189,900 189,400 187,910
disbursements
Net cash flow 182,100 189,250 215,490
Add: Beginning cash 150,000 332,100 521,350
Ending cash 332,100 521,350 736,840
Minimum cash 8,000 8,000 8,000
Required total financing
(notes payable) 0 0 0
Excess cash balance
(marketable securities) 324,100 513,350 728,840
P4-16. Pro forma income statement—scenario analysis
LG 5; Challenge
a.

Pro Forma Income Statement

Allen Products, Inc.
for the Year Ended December 31, 2013
Pessimistic Most Likely Optimistic
Sales $900,000 $1,125,000 $1,280,000
Less cost of goods sold (45%) 405,000 506,250 576,000
Gross profits $495,000 $ 618,750 $ 704,000
Less operating expense (25%) 225,000 281,250 320,000
Operating profits $270,000 $ 337,500 $ 384,000
Less interest expense (3.2%) 28,800 36,000 40,960
Net profit before taxes $241,200 $ 301,500 $ 343,040
Taxes (25%) 60,300 75,375 85,760
Net profits after taxes $180,900 $ 226,125 $ 257,280
 b. The simple percent-of-sales method assumes that all costs are variable. In reality some of
the expenses will be fixed. In the pessimistic case this assumption causes all costs to
decrease with the lower level of sales when in reality the fixed portion of the costs will
not decrease. The opposite occurs for the optimistic forecast since the percent-of-sales
assumes all costs increase when in reality only the variable portion will increase. This
pattern results in an understatement of costs in the pessimistic case and an overstatement
of profits. The opposite occurs in the optimistic scenario.
c.

Pro Forma Income Statement

Allen Products, Inc.
for the Year Ended December 31, 2013
Pessimistic Most Likely Optimistic
Sales $900,000 $1,125,000 $1,280,000
Less cost of goods sold:
Fixed 250,000 250,000 250,000
Variable (18.3%)a 164,700 205,875 234,240
Gross profits $485,300 $ 669,125 $ 795,760
Less operating expense
Fixed 180,000 180,000 180,000
Variable (5.8%)b 52,200 65,250 74,240
Operating profits $253,100 $ 423,875 $ 541,520
Less interest expense 30,000 30,000 30,000
Net profit before taxes $223,100 $ 393,875 $ 511,520
Taxes (25%) 55,775 98,469 127,880
Net profits after taxes $167,325 $ 295,406 $ 383,640
a
Cost of goods sold variable percentage  ($421,875  $250,000) / $937,500
b
Operating expense variable percentage  ($234,375  $180,000) / $937,500

d. The profits for the pessimistic case are larger in part (a) than in part (c). For the optimistic
case, the profits are lower in part (a) than in part (c). This outcome confirms the results as
stated in part (b).

ANSWERS OF ASSIGNMENT 3

P5-6. Personal finance: Time value

LG 2; Challenge
a. (1) N  5, I  2%, PV  $14,000 (2) N  5, I  4%, PV  $14,000
Solve for FV  $15,457.13 Solve for FV $17,033.14
b. The car will cost $1,576.01 more with a 4% inflation rate than an inflation rate of 2%.
This increase is 10.2% more ($1,576  $15,457) than would be paid with only a 2% rate
of inflation.
c. Future value at end of first 2 years:
N  2, I  2%, PV  $14,000
Solve for FV2  $14,565.60
Price rise at end of fifth year:
N  3, I  4%, PV  $14,565.60
Solve for FV5  $16,384.32
As one would expect, the forecast price is between the values calculated with 2% and 4%
interest.
P5-12. Present value concept
LG 2; Intermediate
a. N  6, I  12%, FV  $6,000 b. N  6, I  12%, FV  $6,000
Solve for PV  $3,039.79 Solve for PV  $3,039.79
c. N  6, I  12%, FV  $6,000
Solve for PV  $3,039.79
d. The answer to all three parts is the same. In each case the same question is being asked
but in a different way.

P5-18. Calculating deposit needed

LG 2; Challenge
Step 1: Determination of future value of initial investment
N  7, I  5%, PV  $10,000
Solve for FV  $14,071.00
Step 2: Determination of future value of second investment
$20,000  $14,071  $5,929
Step 3: Calculation of initial investment
N  4, I  5%, FV  $5,929
Solve for PV  $4877.80

P5-19. Future value of an annuity

LG 3; Intermediate
a. Future value of an ordinary annuity vs. annuity due
(1) Ordinary Annuity (2) Annuity Due
A N  10, I  8%, PMT  $2,500 $36,216.41  1.08  $39,113.72
Solve for FV  $36,216.41
B N  6, I  12%, PMT  $500 $4,057.59  1.12  $4,544.51
Solve for FV  $4,057.59
C N  5, I  20%, PMT  $30,000 $223,248  1.20  $267,897.60
Solve for FV  $223,248
D N  8, I  9%, PMT  $11,500 $126,827.47  1.09  $138,241.92
Solve for FV  $126,827.45
E N  30, I  14%, PMT  $6,000 $2,140,721.08  1.14 
$2,440,442/03
Solve for FV  $2,140,721.08
b. The annuity due results in a greater future value in each case. By depositing the payment
at the beginning rather than at the end of the year, it has one additional year of
compounding.

P5-24. Personal finance: Funding your retirement

LG 2, 3; Challenge
a. N  30, I  11%, PMT  $20,000 b. N  20, I  9%, FV 
$173.875.85
Solve for PV  $173,875.85 Solve for PV  $31,024.82
 c. Both values would be lower. In other words, a smaller sum would be needed in 20 years
for
the annuity and a smaller amount would have to be put away today to accumulate the
needed future sum.
d. N  30, I  10%, PMT  $20,000 b. N  20, I  10%, FV 
$188,538.29
Solve for PV  $188,538.29 Solve for PV  $28,025.02
More money will be required to support the $20,000 annuity in retirement because the
initial amount will earn 1% less per year. However, more money will have to be deposited
during the next 20 years because the return on saved funds will be 1% lower.
P5-35. Relationship between future value and present value
LG 4; Intermediate
Step 1: Calculation of present value of known cash flows

Year CFt PV @ 4%
1 $10,000 $9,615.38
2 $5,000 $4,622.78
3 ?
4 $20,000 $17,096.08
5 $3,000 $ 2,465.78
Sum $33,800.02

Step 2: Identify difference between total amount and sum in Step 1.

$32,911.03  $33,800.02  $888.99
Step 3: Calculate the amount needed in 3 years that is worth the Step 2 value today
N  3, I  4%, PV  $888.99
Solve for FV  $999.99

P5-43. Personal finance: Creating a retirement fund

LG 6; Intermediate
a.N  42, I  8%, FV  $220,000 b. N  42, I 8%, PMT  $600
Solve for PMT  $723.10 Solve for FV  $182,546.11

ANSWERS OF ASSIGNMENT 4

P6-3. Personal finance: Real and nominal rates of interest

LG 1; Intermediate
a. Four shirts
b. $100  ($100  0.09)  $109
c. $25  ($25.05)  $26.25
d. The number of polo shirts in one year  $109  $26.25  4.1524. He can buy 3.8% more
shirts (4.1524  4  0.0381).
e. The real rate of return is 9%  5%  4%. The change in the number of shirts that can be
purchased is determined by the real rate of return because the portion of the nominal
return for expected inflation (5%) is available just to maintain the ability to purchase the
same number of shirts.
P6-15. Bond value and changing required returns
Bond Calculator Inputs Calculator Solution
X N  10, YTM 8%, PMT  0.08  $1,000  $80 $1,000
Y N  10, YTM 8%, PMT  0.04 $1,000  $40 $731.60

a.
Bond Calculator Inputs Calculator Solution
(X) N  10, YTM 10%, I  10%, PMT  $80 $877.11
(Y) N  10, YTM 10%, I  10%, PMT  40 $631.33

% change for Bond X =(877.11-1000)/1000 = -12.29%

% change for Bond Y =(631.33-731.60)/731.60 = -13.70%
b.
Bond Calculator Inputs Calculator Solution
(X) N  10, YTM 6%, I  10%, PMT  $80 $1,147.20
(Y) N  10, YTM 6%, I  10%, PMT  40 $852.80

% change for Bond X =(1,147.2-1000)/1000 = 14.72%

% change for Bond Y =(852.80-731.60)/731.60 = 16.57%
c. Bond Y has more interest rate risk.

P6-17. Bond value and changing required returns

LG 5; Intermediate
a.
Bond Calculator Inputs Calculator Solution
(1) N  12, I  11%, PMT  $110, FV  $1,000 $1,000.00
(2) N  12, I  15%, PMT  $110, FV  $1,000 $ 783.18
(3) N  12, I  8%, PMT  $110, FV  $1,000 $1,226.08

b.
 c. When the required return is less than the coupon rate, the market value is greater than the
par value, and the bond sells at a premium. When the required return is greater than the
coupon rate, the market value is less than the par value; the bond therefore sells at a
discount. When the required return is equal to the coupon rate, the market value is equal
to the par value.
d. The required return on the bond is likely to differ from the coupon interest rate because
either
(1) economic conditions have changed, causing a shift in the basic cost of long-term
funds, or
(2) the firm’s risk has changed.

P6-24. Bond valuation—semiannual interest

LG 6; Intermediate
N  10  2  20, rd  8.16  2  4.08%, PMT  0.08  $1,000  2  $40; FV  $1,000
Solve for PV  $989.20