Chapter 17

Financial Statement Analysis

Solutions to Questions

17-1 Horizontal analysis examines how a higher than stockholders could

particular item on a financial statement such as earn in other investments. It
revenue or cost of goods sold behaves over would be better for the company
time. Vertical analysis involves analysis of items to invest in such opportunities
on an income statement or statement of than to pay out dividends and thus
financial position (commonly known as “balance one would expect the company to
sheet”) for a single period. In vertical analysis of have a low dividend payout ratio.
the income statement, all items are typically
stated as a percentage of revenue. In vertical 17-5 The dividend yield is the
analysis of the statement of financial position, all dividend per share divided by the
items are typically stated as a percentage of market price per share. The other
total assets. source of return on an investment
in stock is increases in market
17-2 By looking at trends, an value.
analyst hopes to get some idea of
whether a situation is improving, 17-6 Financial leverage results
remaining the same, or from borrowing funds at an
deteriorating. Such analyses can interest rate that differs from the
provide insight into what is likely rate of return on assets acquired
to happen in the future. Rather using those funds. If the rate of
than looking at trends, an analyst return on the assets is higher than
may compare one company to the interest rate at which the
another or to industry averages funds were borrowed, financial
using common-size financial leverage is positive and
statements. stockholders gain. If the return on
the assets is lower than the
17-3 Price-earnings ratios reflect interest rate, financial leverage is
investors’ expectations concerning negative and the stockholders
future earnings. The higher the lose.
price-earnings ratio, the greater
the growth in earnings investors 17-7 If the company experiences
expect. For this reason, two big variations in net cash flows
companies might have the same from operations, stockholders
current earnings and yet have might be pleased that the
quite different price-earnings company has no debt. In hard
ratios. By definition, a stock with times, interest payments might be
current earnings of $4 and a price- very difficult to meet.
earnings ratio of 20 would be On the other hand, if
selling for $80 per share. investments within the company
can earn a rate of return that
17-4 A rapidly growing tech exceeds the interest rate on debt,
company would probably have stockholders would get the
many opportunities to make benefits of positive leverage if the
investments at a rate of return company took on debt.
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Solutions Manual, Chapter 17 995
17-8 The market value of a share
of common stock often exceeds
the book value per share. Book
value represents the cumulative
effects on the statement of
financial position (balance sheet)
of past activities, evaluated using
historical prices. The market value
of the stock reflects investors’
expectations about the company’s
future earnings. For most
companies, market value exceeds
book value because investors
anticipate future earnings growth.
17-9 A 2 to 1 current ratio might
not be adequate for several
reasons. First, the composition of
the current assets may be heavily
weighted toward slow-turning and
difficult-to-liquidate inventory, or
the inventory may contain large
amounts of obsolete goods.
Second, the receivables may be
low quality, including large
amounts of accounts that may be
difficult to collect.

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996 Managerial Accounting, 14th Edition
The Foundational 15
1. The gross margin percentage and net profit margin percentage are
computed as follows:
Gross margin $300,000
Gross margin percentage= = = 42.9% (rounded)
Revenue $700,000

Net income $92,400

Net profit margin percentage= = = 13.2%
Revenue $700,000

2. The earnings per share is computed as follows:

Net income
Earnings per share =
Average number of common
shares outstanding
$92,400
= = $0.77 per share
120,000 shares

3. The price-earnings ratio is computed as follows:

Market price per share
Price-earnings ratio =
Earnings per share
$2.75
= = 3.57 (rounded)
$0.77

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Solutions Manual, Chapter 17 997
The Foundational 15 (continued)

4. The dividend payout ratio is computed as follows:

Dividends per share
Dividend payout ratio =
Earnings per share
$0.55
= = 71% (rounded)
$0.77

The dividend yield ratio is computed as follows:

Dividends per share
Dividend yield ratio =
Market price per share
$0.55
= = 20%
$2.75

5. The return on total assets is computed as follows:

Net income + [Interest expenses x (1 - Tax rate)]

Return on total Assets =
Average total assets

$92,400 + [$8,000 x (1 - 0.30)]

= = 21.5%
($450,000 + $460,000)/2

6. The return on equity is computed as follows:

Net income $92,400

Return on equity = = = 28%
Average equity ( $320,000+340,000 ) /2

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998 Managerial Accounting, Asia Global Edition
The Foundational 15 (continued)

7. The book value per share is computed as follows:

Total equity
Book value per share =
Number of common shares outstanding

8. The working capital and current ratio are computed as follows:

Working capital = Current assets - Current liabilities
= $150,000 - $60,000 = $90,000
Current assets
Current ratio =
Current liabilities
$150,000
= = 2.50
$60,000

9. The acid-test ratio is computed as follows:

Cash + Marketable securities
+ Accounts receivable + Short-term notes
Acid-test ratio =
Current liabilities
$35,000 + $0 + $60,000 + $0
= = 1.58 (rounded)
$60,000

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Solutions Manual, Chapter 17 999
The Foundational 15 (continued)

10. The accounts receivable turnover is calculated as follows:

Accounts receivable = Sales on account
turnover Average accounts receivable balance
$700,000
= = 12.73 (rounded)
($60,000 + $50,000)/2

The average collection period is computed as follows:

365 days
Average collection period =
Accounts receivable turnover
365 days
= = 28.67 days (rounded)
12.73

11. The inventory turnover is computed as follows:

Cost of goods sold
Inventory turnover =
Average inventory balance
$400,000
= = 6.96 (rounded)
($55,000 + $60,000)/2

The average sale period is computed as follows:

365 days
Average sale period =
Inventory turnover
365 days
= = 52.44 days (rounded)
6.96

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1000 Managerial Accounting, Asia Global Edition
The Foundational 15 (continued)

12. The times interest earned ratio is computed as follows:

Earnings before interest
Times interest = expense and income taxes
earned ratio Interest expense
$140,000
= = 17.5
$8,000

13. The debt-to-equity ratio is computed as follows:

Total liabilities $130,000

Debt-to-equity ratio= = =0.41 ( rounded )
Total equity $320,000

14. The equity multiplier is computed as follows:

Average total assets
Equity multiplier =
Average total equity
($450,000 + $460,000)/2
= =1.38 (rounded)
($320,000 + $340,000)/2

15. The total asset turnover is computed as follows:

Sales
Total asset turnover =
Average total assets
$700,000
= = 1.54 (rounded)
($450,000 + $460,000)/2

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Solutions Manual, Chapter 17 1001
Exercise 17-1 (15 minutes)

1. This Year Last Year

Revenue................................................... 100.0% 100.0%
Cost of goods sold....................................  63.2%  60.0%
Gross margin............................................  36.8%  40.0%
Selling and administrative expenses:
Selling expenses..................................... 18.0% 17.5%
Administrative expenses.........................  13.6%  14.6%
Total selling and administrative expenses...  31.6%  32.1%
Net operating income................................ 5.2% 7.9%
Interest expense.......................................   1.4%   1.0%
Net income before taxes............................   3.8%   6.9%

2. The company’s major problem seems to be the increase in cost of goods

sold, which increased from 60.0% of revenue last year to 63.2% of
revenue this year. This suggests that the company is not passing the
increases in the costs of its products on to its customers. As a result,
cost of goods sold as a percentage of revenue has increased and gross
margin has decreased. Selling expenses and interest expense have both
increased slightly during the year, which suggests that costs generally
are going up in the company. The only exception is the administrative
expenses, which have decreased from 14.6% of revenue last year to
13.6% of revenue this year. This probably is a result of the company’s
efforts to reduce administrative expenses during the year.

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1002 Managerial Accounting, Asia Global Edition
Exercise 17-2 (30 minutes)
1. Calculation of the gross margin percentage:
Gross margin $23,000
Gross margin percentage= = = 34.8%
Revenue $66,000

2. Calculation of the net profit margin percentage:

Net income
Net profit margin percentage=
Revenue

$1 ,980
= = 3%
$66,000

3. Calculation of the earnings per share:

Net income - Preferred dividends
Earnings per share =
Average number of common
shares outstanding
$1,980 - $60
= = $3.20 per share
600 shares
(Note: earnings, dividend and share numbers are in thousands)

4. Calculation of the price-earnings ratio:

Market price per share
Price-earnings ratio =
Earnings per share
$26
= = 8.1
$3.20
5. Calculation of the dividend payout ratio:
Dividends per share
Dividend payout ratio =
Earnings per share
$0.75
= = 23.4%
$3.20
Exercise 17-2 (continued)
6. Calculation of the dividend yield ratio:
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Solutions Manual, Chapter 17 1003
 Dividends per share
Dividend yield ratio =
Market price per share
$0.75
= = 2.9%
$26.00
7. Calculation of the return on total assets:

Net income + [Interest expenses x (1 - Tax rate)]

Return on total Assets =
Average total assets

$1,980 + [$800 x (1 - 0.40)]

= = 3.7%
($65,810 + $68,480)/2

8. Calculation of the return on common stockholders’ (also known as

ordinary shareholders’) equity:
Beginning balance, total equity (a)............... $39,610
Ending balance, total equity (b)...................  41,080
Average total equity [(a) + (b)]/2................ 40,345
Average preferred stock..............................    1,000
Average common stockholders’ equity.......... $39,345

Return on common = Net income - Preferred dividends

stockholders' equity Average common stockholders' equity

$1,980 - $60
= = 4.9%
$39,345
9. Calculation of the book value per share:

Total equity - Preferred stock

Book value per share =
Number of common shares outstanding

$41,080 - $1,000
= = $66.80 per share
600 shares
(Note: equity and preferred stock value, and share numbers are in thousands)

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1004 Managerial Accounting, Asia Global Edition
Exercise 17-3 (30 minutes)
1. Calculation of working capital:

Working capital = Current assets - Current liabilities

= $22,680 - $19,400 = $3,280

2. Calculation of the current ratio:

Current assets
Current ratio =
Current liabilities
$22,680
= = 1.17
$19,400

3. Calculation of the acid-test ratio:

Cash + Marketable securities
+ Accounts receivable + Short-term notes
Acid-test ratio =
Current liabilities
$1,080 + $0 + $9,000 + $0
= = 0.52
$19,400

4. Calculation of accounts receivable turnover:

Accounts receivable = Sales on account
turnover Average accounts receivable balance
$66,000
= = 8.5
($6,500 + $9,000)/2

5. Calculation of the average collection period:

365 days
Average collection period =
Accounts receivable turnover
365 days
= = 42.9 days
8.5

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Solutions Manual, Chapter 17 1005
Exercise 17-3 (continued)
6. Calculation of inventory turnover:
Cost of goods sold
Inventory turnover =
Average inventory balance
$43,000
= = 3.8
($10,600 + $12,000)/2

7. Calculation of the average sale period:

365 days
Average sale period =
Inventory turnover
365 days
= = 96.1 days
3.8

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1006 Managerial Accounting, Asia Global Edition
Exercise 17-4 (15 minutes)
1. Calculation of the times interest earned ratio:
Earnings before interest
Times interest = expense and income taxes
earned ratio Interest expense

$4,100
= = 5.1
$800

3.Calculation of the debt-to-equity ratio:

Total liabilities $27,400

Debt-to-equity ratio= = =0.67 ( rounded )
Total equity $41,080

3. Calculation of the equity multiplier:

Average total assets

Equity multiplier =
Average total equity
($68,480 + $65,810)/2
= =1.66 (rounded)
($41,080 + $39,610)/2

4. Calculation of the total asset turnover:

Revenue
Total asset turnover =
Average total assets
$66,000
= = 0.98 (rounded)
($68,480 + $65,810)/2

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Solutions Manual, Chapter 17 1007
Exercise 17-5 (15 minutes)
1. Current assets
($80,000 + $460,000 + $750,000 + $10,000).... $1,300,000
Current liabilities ($1,300,000 ÷ 2.5)....................     520,000
Working capital.................................................... $  780,000

2. Cash + Marketable securities

+ Accounts receivable + Short-term notes
Acid-test ratio =
Current liabilities
$80,000 + $0 + $460,000 + $0
= =1.04 (rounded)
$520,000

3. a. Working capital would not be affected by a $100,000 payment on

accounts payable:
Current assets ($1,300,000 – $100,000).... $1,200,000
Current liabilities ($520,000 – $100,000)....     420,000
Working capital......................................... $  780,000

b. The current ratio would increase if the company makes a $100,000

payment on accounts payable:
Current assets
Current ratio =
Current liabilities

$1,200,000
= =2.9 (rounded)
$420,000

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1008 Managerial Accounting, Asia Global Edition
Exercise 17-6 (30 minutes)
1. Gross margin percentage:

Gross margin $840,000

Gross margin percentage= = = 40%
Revenue $2,100,000

2. Net profit margin percentage:

Net Income $105,000

Net Profit margin percentage= = = 5%
Revenue $2,100,000

3. Current ratio:
Current assets $490,000
Current ratio= = =2.45
Current liabilities $200,000

4. Acid-test ratio:
Cash + Marketable securities
+ Accounts receivable + Short-term notes
Acid test ratio=
Current liabilities
$21,000 + $0 + $160,000 + $0
= =0.91 (rounded)
$200,000

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Solutions Manual, Chapter 17 1009
Exercise 17-6 (continued)

5. Average collection period:

Sales on account
Accounts receivable turnover=
Average accounts receivable
$2,100,000
= =14
($160,000 + $140,000)/2
365 days
Average collection period =
Accounts receivable turnover
365 days
= =26.1 days (rounded)
14

6. Average sale period:

Cost of goods sold
Inventory turnover=
Average inventory
$1,260,000
= =4.5
($300,000 + $260,000)/2
365 days
Average sale period= =81.1 days (rounded)
4.5

7. Debt-to-equity ratio:
Total liabilities $500,000
Debt-to-equity ratio= = =0.63 ( rounded )
Total equity $800,000

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1010 Managerial Accounting, Asia Global Edition
Exercise 17-6 (continued)

8. Times interest earned:

Earnings before interest
and income taxes
Times interest earned=
Interest expense

$180,000
= = 6.0
$30,000

9. Book value per share:

Total equity - Preferred stock

Book value per share =
Number of common shares outstanding

$800,000 - $0
= = $40 per share
20,000 shares*

*$100,000 total par value ÷ $5 par value per share = 20,000 shares

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Solutions Manual, Chapter 17 1011
Exercise 17-7 (20 minutes)
1. Earnings per share:

Net income - Preferred dividends

Earnings per share =
Average number of common shares outstanding

$105,000 - $0
= = $5.25 per share
20,000 shares

2. Dividend payout ratio:

Dividends per share $3.15
Dividend payout ratio= = =60%
Earnings per share $5.25

3. Dividend yield ratio:

Dividends per share $3.15
Dividend yield ratio= = =5%
Market price per share $63.00

4. Price-earnings ratio:
Market price per share $63.00
Price-earnings ratio= = =12.0
Earnings per share $5.25

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1012 Managerial Accounting, Asia Global Edition
Exercise 17-8 (20 minutes)
1. Return on total assets:

Net income + [Interest expenses x (1 - Tax rate)]

Return on total Assets =
Average total assets

$105,000 + [$30,000 x (1 - 0.30)] $126,000

= ¿ = 10.5%
($1,100,000 + $1,300,000)/2 $1,200,000

2. Return on common stockholders’ equity:

Return on common Net income - Preferred dividends

=
Average total equity - Average preferred stock
stockholders’ equity
$105,000 - $0
=
($725,000 - $800,000)/2 - $0
$105,000
= = 13.8% (rounded)
$762,500

3. Financial leverage was positive because the rate of return to the

common stockholders (13.8%) was greater than the rate of return on
total assets (10.5%). This positive leverage is traceable in part to the
company’s current liabilities, which may carry no interest cost, and to
the bonds payable, which have an after-tax interest cost of only 7%.
10% interest rate × (1 – 0.30) = 7%

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Solutions Manual, Chapter 17 1013
Exercise 17-9 (20 minutes)
1. Return on total assets:

Net income + [Interest expenses x (1 - Tax rate)]

Return on total Assets =
Average total assets

$470,000 + [$90,000 x (1 - 0.30)] $533,000

= ¿ = 10.9% (rounded)
($5,000,000 + $48,000,000)/2 $4,900,000

2. Return on common stockholders’ equity:

Average total equity (i.e. total stockholders’ equity)
($3,100,000 + $2,900,000)/2................................ $3,000,000
Average preferred stock ($800,000 + $800,000)/2....     800,000
Average common stockholders’ equity...................... $2,200,000

Return on common = Net income - Preferred dividends

stockholders' equity Average common stockholders' equity

$470,000 - $56,000
= =18.8% (rounded)
$2,200,000

3. Leverage is positive because the return on common stockholders’ equity

(18.8%) is greater than the return on total assets (10.9%). This positive
leverage arises from the long-term debt, which has an after-tax interest
cost of only 8.4% [12% interest rate × (1 – 0.30)], and the preferred
stock, which carries a dividend rate of only 7%. Both of these figures
are smaller than the return that the company is earning on its total
assets; thus, the difference goes to the common stockholders.

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1014 Managerial Accounting, Asia Global Edition
Exercise 17-10 (15 minutes)
1. The trend percentages are:
Year 5 Year 4 Year 3 Year 2 Year 1
Revenue.............................. 125.0 120.0 110.0 105.0 100.0
Current assets:
Cash................................. 80.0 90.0 105.0 110.0 100.0
Accounts receivable........... 140.0 124.0 108.0 104.0 100.0
Inventory.......................... 112.0 110.0 102.0 108.0 100.0
Total current assets............. 118.8 113.1 104.1 106.9 100.0
Current liabilities.................. 130.0 106.0 108.0 110.0 100.0

2. Revenue: Revenues are increasing at a steady rate, with a particularly

strong gain in Year 4.
Assets: Cash declined from Year 3 through Year 5. This may have
been due to the growth in both inventories and accounts
receivable. In particular, the accounts receivable grew far
faster than revenue in Year 5. The decline in cash may reflect
delays in collecting receivables. This is a matter for
management to investigate further.
Liabilities: The current liabilities jumped up in Year 5. This was probably
due to the buildup in accounts receivable in that the
company doesn’t have the cash needed to pay bills as they
come due.

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Solutions Manual, Chapter 17 1015
Problem 17-11 (60 minutes)

This Year Last Year

1.
a. Current assets (a)................................... $2,060,000 $1,470,000
Current liabilities (b)................................  1,100,000     600,000
Working capital (a) − (b)......................... $  960,000 $  870,000

b. Current assets (a)................................... $2,060,000 $1,470,000

Current liabilities (b)................................ $1,100,000 $600,000
Current ratio (a) ÷ (b)............................. 1.87 2.45

c. Quick assets (a)...................................... $740,000 $650,000

Current liabilities (b)................................ $1,100,000 $600,000
Acid-test ratio (a) ÷ (b)........................... 0.67 1.08

d. Sales on account (a)............................... $7,000,000 $6,000,000

Average receivables (b)........................... $525,000 $375,000
Accounts receivable turnover (a) ÷ (b)..... 13.3 16.0
Average collection period: 365 days ÷
accounts receivable turnover................. 27.4 days 22.8 days

e. Cost of goods sold (a)............................. $5,400,000 $4,800,000

Average inventory (b)............................. $1,050,000 $760,000
Inventory turnover ratio (a) ÷ (b)............ 5.1 6.3
Average sale period:
365 days ÷ inventory turnover.............. 71.6 days 57.9 days

Total liabilities (a)................................... $1,850,000 $1,350,000

Total equity (b)....................................... $2,150,000 $1,950,000
Debt-to-equity ratio (a) ÷ (b).................. 0.86 0.69

g. Net income before interest and taxes (a).. $630,000 $490,000

Interest expense (b)............................... $90,000 $90,000
Times interest earned (a) ÷ (b)............... 7.0 5.4

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1016 Managerial Accounting, Asia Global Edition
Problem 17-11 (continued)
2.
a.
Modern Building Supply

Common-Size Statements of Financial Position

(Balance sheets)

This Year
Last Year

Assets

Noncurrent assets:

Plant and equipment, net.......

 48.5%
 55.5%

Current assets:

Accounts receivable, net........

16.3%
12.1%

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Solutions Manual, Chapter 17 1017
 Inventory..............................
32.5%
24.2%

Prepaid expenses..................
   0.5%
   0.6%

Marketable securities.............
0.0%
1.5%

Cash.....................................
2.3%
6.1%

Total current assets.................

51.5%
44.5%

Total assets.............................
100.0%
100.0%

Equity and Liabilities

Equity:
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1018 Managerial Accounting, Asia Global Edition
 Common stock, $10 par.........
12.5%
15.2%

Preferred stock, $50 par, 8%.

5.0%
6.1%

Retained earnings.................
 36.3%
 37.9%

Total equity.............................
 53.8%
 59.1%

Liabilities:

Current liabilities...................
27.5%
18.2%

Bonds payable, 12%.............

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Solutions Manual, Chapter 17 1019
  18.8%
 22.7%

Total liabilities.........................
 46.3%
 40.9%

Total equity and liabilities.........

100.0%
100.0%

Note: Columns may not total down due to rounding.

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1020 Managerial Accounting, Asia Global Edition
Problem 17-11 (continued)
b. Modern Building Supply
Common-Size Income Statements
This Year Last Year
Revenue........................................... 100.0% 100.0%
Cost of goods sold............................  77.1%  80.0%
Gross margin.................................... 22.9% 20.0%
Selling and administrative expenses...  13.9%  11.8%
Net operating income........................ 9.0% 8.2%
Interest expense...............................   1.3%   1.5%
Net income before taxes...................   7.7%   6.7%
Income taxes...................................   3.1%   2.7%
Net income.......................................   4.6%   4.0%

3. The following points can be made from the analytical work in parts (1)
and (2) above:
a. The company has improved its profit margin from last year. This is
attributable primarily to an increase in gross margin, which is offset
somewhat by an increase in operating expenses. In both years the
company’s net income as a percentage of revenue equals or exceeds
the industry average of 4%.
b. The company’s current position has deteriorated significantly since
last year. Both the current ratio and the acid-test ratio are well below
the industry average, and both are trending downward. At the
present rate, it will soon be impossible for the company to pay its bills
as they come due.

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Solutions Manual, Chapter 17 1021
Problem 17-11 (continued)
c. The drain on the cash account seems to be a result mostly of a large
buildup in accounts receivable and inventory. Notice that the average
collection period has increased by 4.6 days since last year, and that it
is now 9 days over the industry average. Many of the company’s
customers are not taking their discounts, since the average collection
period is 27 days and collection terms are 2/10, n/30. This suggests
financial weakness on the part of these customers, or sales to
customers who are poor credit risks.
d. The inventory turned only 5 times this year as compared to over 6
times last year. It takes three weeks longer for the company to turn
its inventory than the average for the industry (71 days as compared
to 50 days for the industry). This suggests that inventory stocks are
higher than they need to be.
e. In the authors’ opinion, the loan should be approved only if the
company gets its accounts receivable and inventory back under
control. If the accounts receivable collection period is reduced to
about 20 days, and if the inventory is pared down enough to reduce
the turnover time to about 60 days, enough funds could be released
to substantially improve the company’s cash position. Then a loan
might not even be needed.

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1022 Managerial Accounting, Asia Global Edition
Problem 17-12 (60 minutes)

a.
1. This Year Last Year
Net income........................................... $324,000 $240,000
Less preferred dividends........................    16,000    16,000
Net income remaining for common (a). . . $308,000 $224,000
Average number of common shares (b). . 50,000 50,000
Earnings per share (a) ÷ (b).................. $6.16 $4.48

b. Dividends per share (a)*........................ $2.16 $1.20

Market price per share (b)..................... $45.00 $36.00
Dividend yield ratio (a) ÷ (b)................. 4.8% 3.33%
*$108,000 ÷ 50,000 shares = $2.16;
$60,000 ÷ 50,000 shares = $1.20

c. Dividends per share (a)......................... $2.16 $1.20

Earnings per share (b).......................... $6.16 $4.48
Dividend payout ratio (a) ÷ (b).............. 35.1% 26.8%

d. Market price per share (a)..................... $45.00 $36.00

Earnings per share (b).......................... $6.16 $4.48
Price-earnings ratio (a) ÷ (b)................. 7.3 8.0
Investors regard Modern Building Supply less favorably than other
companies in the industry. This is evidenced by the fact that they are
willing to pay only 7.3 times current earnings for a share of the
company’s stock, as compared to 9 times current earnings for other
companies in the industry. If investors were willing to pay 9 times
current earnings for Modern Building Supply’s stock, then it would be
selling for about $55 per share (9 × $6.16), rather than for only $45
per share.

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Solutions Manual, Chapter 17 1023
Problem 17-12 (continued)

This Year Last Year

e. Total equity........................................ $2,150,000 $1,950,000
Less preferred stock...........................     200,000     200,000
Common stockholders’ equity (a)......... $1,950,000 $1,750,000
Number of common shares
outstanding (b)................................ 50,000 50,000
Book value per share (a) ÷ (b)............ $39.00 $35.00

The market value is above book value for both years. However, this
does not necessarily indicate that the stock is overpriced. Market
value reflects investors’ perceptions of future earnings, whereas book
value is a result of already completed transactions.

2.
a. Net income......................................... $  324,000 $  240,000
Add after-tax cost of interest paid:
[$90,000 × (1 – 0.40)].....................       54,000       54,000
Total (a)............................................ $  378,000 $  294,000
Average total assets (b)...................... $3,650,000 $3,000,000
Return on total assets (a) ÷ (b)........... 10.4% 9.8%

b. Net income......................................... $  324,000 $  240,000

Less preferred dividends.....................       16,000       16,000
Net income remaining for common (a). $  308,000 $  224,000
Average total equity*.......................... $2,050,000 $1,868,000
Less average preferred stock...............     200,000     200,000
Average common stockholders’ equity
(b).................................................. $1,850,000 $1,668,000

*1/2($2,150,000 + $1,950,000); 1/2($1,950,000 + $1,786,000)

Return on common stockholders’
equity (a) ÷ (b)............................... 16.6% 13.4%

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1024 Managerial Accounting, Asia Global Edition
Problem 17-12 (continued)
c. Financial leverage is positive in both years because the return on
common equity is greater than the return on total assets. This
positive financial leverage is due to three factors: the preferred stock,
which has a dividend of only 8%; the bonds, which have an after-tax
interest cost of only 7.2% [12% interest rate × (1 – 0.40) = 7.2%];
and the accounts payable, which may bear no interest cost.

d. The company invested significantly more assets including plant and

equipment to support its expansion and growth. Its revenue increased
by $1,000,000 to $7,000,000 while net income only increased by
$84,000 to $324,000. Profitability of the increased business raises
some concern. The growth in business also increased its accounts
receivable and inventory at the year end. These increases in current
assets can be seen as funded by accounts payable and cash.

Total assets increased by $700,000 (21% of previous year asset total)

to $4,000,000. Its return on total assets improved marginally from
9.8% to 10.4%. On the books, it seems to have improvement in asset
efficiency. However, the significant increase in inventory of $500,000
to $1,300,000 at the year-end raises some concern as this effectively
representing an average inventory sales period of 71 days (
365 days 365 365
= = =71 days
Inventory turnover Cost of goods sold 5,400 ) which was a
Average inventory (1,300+800)/2
bit high. This increase also represented 50% of the $1,000,000
increased revenue in the period. The significant increase in inventory
at the year-end could also be a result of profit manipulation by
deferring some manufacturing overhead to the next period. Due to the
absence of the detail information on asset purchasing period, we can
only conclude that the analysis does not provide strong support on
significant improvement on asset utilization. More information, such as
average asset returns from its competitors and industry, timing of
asset purchase, monthly revenue trends and order books, is required
to provide a concrete conclusion.

3. We would recommend keeping the stock. The stock’s downside risk

seems small because it is selling for only 7.3 times current earnings as
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Solutions Manual, Chapter 17 1025
 compared to 9 times earnings for other companies in the industry. In
addition, its earnings are strong and trending upward, and its return on
common equity (16.6%) is extremely good. Its return on total assets
(10.4%) compares well with that of the industry. The risk, of course, is
whether the company can get its cash problem under control.
Conceivably, the cash problem could worsen, leading to an eventual
reduction in profits, a reduction in dividends, and a precipitous drop in
the market price of the company’s stock. This does not seem likely,
however, since the company can easily control its cash problem through
more careful management of accounts receivable and inventory. The
risks associated with retaining the stock seem justified in this case
because the upward potential of the stock is great if the company gets
its problems under control.

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1026 Managerial Accounting, Asia Global Edition
Problem 17-13 (30 minutes)
a. The market price is going down. The dividends paid per share over the
three-year period are unchanged, but the dividend yield is going up.
Therefore, the market price per share of stock must be decreasing.
b. The earnings per share is increasing. Again, the dividends paid per
share have remained constant. However, the dividend payout ratio is
decreasing. In order for the dividend payout ratio to be decreasing, the
earnings per share must be increasing.
c. The price-earnings ratio is going down. If the market price of the stock
is going down [see part (a) above], and the earnings per share are
going up [see part (b) above], then the price-earnings ratio must be
decreasing.
d. In Year 1, leverage was negative because in that year the return on
total assets exceeded the return on common equity. In Year 2 and in
Year 3, leverage was positive because in those years the return on
common equity exceeded the return on total assets employed.
e. It is becoming more difficult for the company to pay its bills as they
come due. Although the current ratio has improved over the three
years, the acid-test ratio is down. Also note that the accounts receivable
and inventory are both turning more slowly, indicating that an
increasing portion of the current assets is being made up of those items,
from which bills cannot be paid.
f. Customers are paying their bills more slowly in Year 3 than in Year 1.
This is evidenced by the decline in accounts receivable turnover.
g. Accounts receivable is increasing. This is evidenced both by a slowdown
in turnover and in an increase in total sales.
h. The level of inventory undoubtedly is increasing. Notice that the
inventory turnover is decreasing. Even if revenue (and cost of goods
sold) just remained constant, this would be evidence of a larger average
inventory on hand. However, revenues are not constant but rather are
increasing. With revenues increasing (and undoubtedly cost of goods
sold also increasing), the average level of inventory must be increasing
as well in order to service the larger volume of sales.

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Solutions Manual, Chapter 17 1027
Problem 17-14 (30 minutes)
1. a. Computation of working capital:
Current assets:
Accounts receivable, net............ $350,000
Inventory.................................. 460,000
Prepaid expenses......................     8,000
Marketable securities................. 12,000
Cash......................................... 70,000
Total current assets (a)................  900,000
Current liabilities:
Accounts payable...................... 200,000
Accrued liabilities....................... 60,000
Notes due in one year...............  100,000
Total current liabilities (b)............  360,000
Working capital (a) − (b)............. $540,000

b. Computation of the current ratio:

Current assets $900,000
Current ratio= = =2.5
Current liabilities $360,000
c. Computation of the acid-test ratio:
Cash + Marketable securities
+ Accounts receivable + Short-term notes
Acid-test ratio=
Current liabilities
$70,000 + $12,000 + $350,000 $432,000
= = =1.2
$360,000 $360,000

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1028 Managerial Accounting, Asia Global Edition
Problem 17-14 (continued)

2. The Effect on
Acid-
Working Current Test
Transaction Capital Ratio Ratio
(a) Declared a cash dividend................. Decrease Decrease Decrease
(b) Paid accounts payable..................... None Increase Increase
(c) Collected accounts receivable........... None None None
(d) Purchased equipment for cash......... Decrease Decrease Decrease
(e) Paid a cash dividend previously
declared....................................... None Increase Increase
(f) Borrowed on a short-term note........ None Decrease Decrease
(g) Sold inventory at a profit................. Increase Increase Increase
(h) Wrote off uncollectible accounts....... None None None
(i) Sold marketable securities at a loss Decrease Decrease Decrease
(j) Issued common stock for cash......... Increase Increase Increase
(k) Paid off short-term notes................. None Increase Increase

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Solutions Manual, Chapter 17 1029
Problem 17-15 (45 minutes)
Effect on
Ratio Reason for Increase, Decrease, or No Effect
1. Decrease Sale of inventory at a profit will be reflected in an increase
in retained earnings, which is part of stockholders’ equity.
An increase in stockholders’ equity will result in a decrease
in the ratio of assets provided by creditors as compared to
assets provided by owners.
2. No effect Purchasing land for cash has no effect on earnings or on
the number of shares of common stock outstanding. One
asset is exchanged for another.
3. Increase A sale of inventory on account will increase the quick assets
(cash, accounts receivable, marketable securities) but have
no effect on the current liabilities. For this reason, the acid-
test ratio will increase.
4. No effect Payments on account reduce cash and accounts payable by
equal amounts; thus, the net amount of working capital is
not affected.
5. Decrease When a customer pays a bill, the accounts receivable
balance is reduced. This increases the accounts receivable
turnover, which in turn decreases the average collection
period.
6. Decrease Declaring a cash dividend will increase current liabilities,
but have no effect on current assets. Therefore, the current
ratio will decrease.
7. Increase Payment of a previously declared cash dividend will reduce
both current assets and current liabilities by the same
amount. An equal reduction in both current assets and
current liabilities will always result in an increase in the
current ratio, so long as the current assets exceed the
current liabilities.
8. No effect Book value per share is not affected by the current market
price of the company’s stock.

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1030 Managerial Accounting, Asia Global Edition
Problem 17-15 (continued)
Effect on
Ratio Reason for Increase, Decrease, or No Effect
9. Decrease The dividend yield ratio is obtained by dividing the dividend
per share by the market price per share. If the dividend
per share remains unchanged and the market price goes
up, then the yield will decrease.
10. Increase Selling property for a profit would increase net income and
therefore the return on total assets would increase.
11. Increase A write-off of inventory will reduce the inventory balance,
thereby increasing the turnover in relation to a given level
of cost of goods sold.
12. Increase Since the company’s assets earn at a rate that is higher
than the rate paid on the bonds, leverage is positive,
increasing the return to the common stockholders.
13. No effect Changes in the market price of a stock have no direct
effect on the dividends paid or on the earnings per share
and therefore have no effect on this ratio.
14. Decrease A decrease in net income would mean less income
available to cover interest payments. Therefore, the times-
interest-earned ratio would decrease.
15. No effect Write-off of an uncollectible account against the Allowance
for Bad Debts will have no effect on total current assets.
For this reason, the current ratio will remain unchanged.
16. Decrease A purchase of inventory on account will increase current
liabilities, but will not increase the quick assets (cash,
accounts receivable, marketable securities). Therefore, the
ratio of quick assets to current liabilities will decrease.
17. Increase The price-earnings ratio is obtained by dividing the market
price per share by the earnings per share. If the earnings
per share remains unchanged, and the market price goes
up, then the price-earnings ratio will increase.
18. Decrease Payments to creditors will reduce the total liabilities of a
company, thereby decreasing the ratio of total debt to total
equity.

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Solutions Manual, Chapter 17 1031
Problem 17-16 (90 minutes)

1.
a. This Year Last Year
Net income........................................... $  280,000 $  168,000
Add after-tax cost of interest:
$120,000 × (1 – 0.30)........................ 84,000
$100,000 × (1 – 0.30)........................                       70,000
Total (a)............................................... $  364,000 $  238,000
Average total assets (b)........................ $5,330,000 $4,640,000
Return on total assets (a) ÷ (b)............. 6.8% 5.1%

b. Net income........................................... $  280,000 $  168,000

Less preferred dividends.......................       48,000       48,000
Net income remaining for common (a)... $  232,000 $  120,000
Average total equity.............................. $3,120,000 $3,028,000
Less average preferred stock.................     600,000     600,000
Average common equity (b).................. $2,520,000 $2,428,000
Return on common stockholders’ equity
(a) ÷ (b)............................................ 9.2% 4.9%

c. Leverage is positive for this year because the return on common

equity (9.2%) is greater than the return on total assets (6.8%). For
last year, leverage is negative because the return on the common
equity (4.9%) is less than the return on total assets (5.1%).

2.
a. Net income remaining for common [see
above] (a)......................................... $232,000 $120,000
Average number of common shares
outstanding (b).................................. 50,000 50,000
Earnings per share (a) ÷ (b).................. $4.64 $2.40

b. Dividends per share (a)......................... $1.44 $0.72

Market price per share (b)..................... $36.00 $20.00
Dividend yield ratio (a) ÷ (b)................. 4.0% 3.6%

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1032 Managerial Accounting, Asia Global Edition
Problem 17-16 (continued)

This Year Last Year

c. Dividends per share (a)......................... $1.44 $0.72
Earnings per share (b).......................... $4.64 $2.40
Dividend payout ratio (a) ÷ (b).............. 31.0% 30.0%
d. Market price per share (a)...................... $36.00 $20.00
Earnings per share (b)........................... $4.64 $2.40
Price-earnings ratio (a) ÷ (b).................. 7.8 8.3
Notice from the data given in the problem that the typical P/E ratio
for companies in Hedrick’s industry is 10. Hedrick Company presently
has a P/E ratio of only 7.8, so investors appear to regard it less well
than they do other companies in the industry. That is, investors are
willing to pay only 7.8 times current earnings for a share of Hedrick
Company’s stock, as compared to 10 times current earnings for a
share of stock for the typical company in the industry.
e. Total equity.......................................... $3,200,000 $3,040,000
Less preferred stock..............................     600,000     600,000
Common stockholders’ equity (a)........... $2,600,000 $2,440,000
Number of common shares outstanding
(b).................................................... 50,000 50,000
Book value per share (a) ÷ (b).............. $52.00 $48.80
Note that the book value of Hedrick Company’s stock is greater than
its market value for both years. This does not necessarily indicate
that the stock is selling at a bargain price. Market value is an
indication of investors’ perceptions of future earnings and/or
dividends, whereas book value is a result of already completed
transactions.
Gross margin (a)................................... $1,050,000 $860,000
Revenue (b)......................................... $5,250,000 $4,160,000
Gross margin percentage (a) ÷ (b)........ 20.0% 20.7%
g. Net income (a)..................................... $280,000 $168,000
Revenue (b)......................................... $5,250,000 $4,160,000
Net Profit margin percentage (a) ÷ (b). . 5.3% 4.0%

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Solutions Manual, Chapter 17 1033
Problem 17-16 (continued)

This Year Last Year

3.
a. Current assets (a)................................... $2,600,000 $1,980,000
Current liabilities (b)................................  1,300,000     920,000
Working capital (a) − (b)......................... $1,300,000 $1,060,000
b. Current assets (a)................................... $2,600,000 $1,980,000
Current liabilities (b)................................ $1,300,000 $920,000
Current ratio (a) ÷ (b)............................. 2.0 2.15
c. Quick assets (a)...................................... $1,220,000 $1,120,000
Current liabilities (b)................................ $1,300,000 $920,000
Acid-test ratio (a) ÷ (b)........................... 0.94 1.22
d. Sales on account (a)............................... $5,250,000 $4,160,000
Average receivables (b)........................... $750,000 $560,000
Accounts receivable turnover (a) ÷ (b)..... 7.0 7.4
Average collection period: 365 days ÷
accounts receivable turnover................. 52 days 49 days
e. Cost of goods sold (a)............................. $4,200,000 $3,300,000
Average inventory balance (b)................. $1,050,000 $720,000
Inventory turnover ratio (a) ÷ (b)............ 4.0 4.6
Average sales period: 365 days ÷
inventory turnover ratio........................ 91 days 79 days
Total liabilities (a)................................... $2,500,000 $1,920,000
Total equity (b)....................................... $3,200,000 $3,040,000
Debt-to-equity ratio (a) ÷ (b).................. 0.78 0.63
g. Net income before interest and income
taxes (a).............................................. $520,000 $340,000
Interest expense (b)............................... $120,000 $100,000
Times interest earned (a) ÷ (b)............... 4.3 3.4
h. Average total assets (a).......................... $5,300,000 $4,640,000
Average equity (b).................................. $3,120,000 $3,028,000
Equity Multiplier (a) ÷ (b)........................ 1.70 1.53
The beginning total assets and total equity figures of last year were
given in question 1a and 1b, respectively.

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1034 Managerial Accounting, Asia Global Edition
 Problem 17-16 (continued)
4. As stated by Marva Rossen, both net income and revenue are up from
last year. The return on total assets has improved from 5.1% last year
to 6.8% this year, and the return on common equity is up to 9.2% from
4.9% the year before. But this appears to be the only bright spot.
Virtually all other ratios are below what is typical for the industry, and,
more important, they are trending downward. The deterioration in the
gross margin percentage, while not large, is worrisome. Revenue and
inventories have increased substantially, which should ordinarily result in
an improvement in the gross margin percentage as fixed costs are
spread over more units. However, the gross margin percentage has
declined.
Notice that the average collection period has lengthened to 52 days—
about three weeks over the industry average—and that the average sale
period is 50% longer than the industry norm. The increase in revenue
may have been obtained at least in part by extending credit to high-risk
customers. Also notice that the debt-to-equity ratio is rising rapidly. If
the $1,000,000 loan is granted, the ratio will rise further to 1.09.
In our opinion, what the company needs is more equity—not more debt.
Therefore, the loan should not be approved. The company should be
encouraged to issue more common stock.

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Solutions Manual, Chapter 17 1035
Problem 17-17 (30 minutes)
1. Hedrick Company
Comparative Statements of Financial Position
This Year Last Year
Assets
Noncurrent assets:
Plant and equipment, net...............  54.4%  60.1%
Current assets:
Accounts receivable, net................. 15.8% 12.1%
Inventory...................................... 22.8% 16.1%
Prepaid expenses...........................    1.4%    1.2%
Marketable securities...................... 0.0% 2.0%
Cash............................................. 5.6% 8.5%
Total current assets.......................... 45.6% 39.9%
Total assets...................................... 100.0% 100.0%
Equity and liabilities
Equity:
Preferred stock, 8%, $30 par value. 10.5% 12.1%
Common stock, $40 par value......... 35.1% 40.3%
Retained earnings..........................  10.5%    8.9%
Total equity......................................  56.1%  61.3%
Liabilities:
Current liabilities............................ 22.8% 18.5%
Bonds payable, 10%......................  21.1%  20.2%
Total liabilities..................................  43.9%  38.7%
Total equity and liabilities.................. 100.0% 100.0%

Note: Columns may not total down due to rounding.

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1036 Managerial Accounting, Asia Global Edition
Problem 17-17 (continued)
2. Hedrick Company
Comparative Income Statements
This Year Last Year
Revenue.......................................... 100.0% 100.0%
Cost of goods sold.............................  80.0%  79.3%
Gross margin.................................... 20.0% 20.7%
Selling and administrative expenses....  10.1%  12.5%
Net operating income........................ 9.9% 8.2%
Interest expense...............................   2.3%   2.4%
Net income before taxes.................... 7.6% 5.8%
Income taxes (30%).........................   2.3%   1.7%
Net income.......................................   5.3%   4.0%

*Due to rounding, figures may not fully reconcile down a column.

3. The company’s current position has declined substantially between the

two years. Cash this year represents only 5.6% of total assets, whereas
it represented 10.5% last year (Cash + Marketable Securities). In
addition, both accounts receivable and inventory are up from last year,
which helps to explain the decrease in the Cash account. The company
is building inventories, but not collecting from customers. (See Problem
17-16 for a ratio analysis of the current assets.) Apparently, part of the
financing required to build inventories was supplied by short-term
creditors, as evidenced by the increase in current liabilities.
Looking at the income statement, the gross margin percentage has
deteriorated. Ordinarily, the increase in revenue (and in inventories)
should have resulted in an increase in the gross margin percentage
since fixed manufacturing costs would be spread across more units.
Note that the other operating expenses are down as a percentage of
revenue—possibly because of the existence of fixed expenses.

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Solutions Manual, Chapter 17 1037
Problem 17-18 (45 minutes)
1. The loan officer stipulated that the current ratio prior to obtaining the
loan must be higher than 2.0, the acid-test ratio must be higher than
1.0, and the interest on the loan must be no more than one-fourth of
net operating income. These ratios are computed below:
Current assets
Current ratio =
Current liabilities
$435,000
= = 1.8 (rounded)
$246,000
Cash + Marketable securities
+ Accounts receivable + Short-term notes
Acid-test ratio =
Current liabilities
$105,000 + $0 + $75,000 + $0
= = 0.7 (rounded)
$246,000
Net operating income $30,000
= = 5.0
Interest on the loan $120,000 × 0.10 × (6/12)

The company would not qualify for the loan because both its current
ratio and its acid-test ratio are too low.

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1038 Managerial Accounting, Asia Global Edition
Problem 17-18 (continued)
2. By reclassifying the $68 thousand net book value of the old equipment
as inventory, the current ratio would improve, but the acid-test ratio
would be unaffected. Inventory is considered a current asset for
purposes of computing the current ratio, but is not included in the
numerator when computing the acid-test ratio.
Current assets
Current ratio =
Current liabilities
$435,000 + $68,000
= = 2.0 (rounded)
$246,000

Cash + Marketable securities

+ Accounts receivable + Short-term notes
Acid-test ratio =
Current liabilities
$105,000 + $0 + $75,000 + $0
= = 0.7 (rounded)
$246,000
Even if this tactic had succeeded in qualifying the company for the loan,
we strongly advise against it. Inventories are assets the company has
acquired to sell to customers in the normal course of business. Used
production equipment is not inventory—even if there is a clear intention
to sell it in the near future. The loan officer would not expect used
equipment to be included in inventories; doing so would be intentionally
misleading.

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Solutions Manual, Chapter 17 1039
Problem 17-18 (continued)
Nevertheless, the old equipment is an asset that could be turned into
cash. If this were done, the company would immediately qualify for the
loan since the $68 thousand in cash would be included in the numerator
in both the current ratio and in the acid-test ratio.
Current assets
Current ratio =
Current liabilities
$435,000 + $68,000
= = 2.0 (rounded)
$246,000

Cash + Marketable securities

+ Accounts receivable + Short-term notes
Acid-test ratio =
Current liabilities
($105,000 + $68,000) + $0 + $75,000 + $0
=
$246,000
= 1.0 (rounded)

However, other options may be available. The old equipment is being

used to relieve bottlenecks in the heat-treating process and it would be
desirable to keep this standby capacity. We would advise Jurgen to fully
and honestly explain the situation to the loan officer. The loan officer
might insist that the equipment be sold before any loan is approved, but
she might instead grant a waiver of the current ratio and acid-test ratio
requirements on the basis that they could be satisfied by selling the old
equipment. Or she may approve the loan on the condition that the
equipment is pledged as collateral. In that case, Jurgen would only have
to sell the equipment if he would otherwise be unable to pay back the
loan.

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1040 Managerial Accounting, Asia Global Edition
Problem 17-19 (60 minutes or longer)

Tanner Company
Income Statement
For the Year Ended December 31
Key
Revenue................................................. $2,700,000
Cost of goods sold..................................  1,800,000 (h)
Gross margin.......................................... 900,000 (i)
Selling and administrative expenses.........     585,000 (j)
Net operating income.............................. 315,000 (a)
Interest expense.....................................      45,000
Net income before taxes.......................... 270,000 (b)
Income taxes (40%)...............................     108,000 (c)
Net income............................................. $  162,000 (d)

Tanner Company
Statement of Financial Position
December 31
Assets
Noncurrent assets:
Plant and equipment............................. $   900,000 (q)
Current assets:
Accounts receivable, net....................... 200,000 (e)
Inventory.............................................     320,000 (g)
Cash....................................................     80,000 (f)
Total current assets................................ 600,000 (g)
Total assets............................................ $1,500,000 (p)
Equity and Liabilities
Equity:
Common stock, $2.50 par value............ 100,000 (m)
Retained earnings.................................     700,000 (o)
Total equity............................................     800,000 (n)
Liabilities:
Current liabilities.................................. $  250,000
Bonds payable, 10%.............................     450,000 (k)
Total liabilities.........................................     700,000 (l)
Total equity and liabilities........................ $1,500,000 (p)

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Solutions Manual, Chapter 17 1041
Problem 17-19 (continued)
Computation of missing amounts:

a. Earnings before interest and taxes

Times interest earned =
Interest expense
Earnings before interest and taxes
=
$45,000
= 7.0
Therefore, the earnings before interest and taxes for the year must be
$315,000 (= $45,000 × 7.0).

b. Net income before taxes = $315,000 – $45,000 = $270,000.

c. Income taxes = $270,000 × 40% tax rate = $108,000.

d. Net income = $270,000 – $108,000 = $162,000.

e. Accounts receivable = Sales on account

turnover Average accounts receivable balance
$2,700,000
= = 15.0
Average accounts receivable balance
Average accounts = $2,700,000 ÷ 15.0 = $180,000
receivable balance

Therefore, the average accounts receivable balance for the year must
have been $180,000. The beginning balance was $160,000, so the
ending balance must have been $200,000.

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1042 Managerial Accounting, Asia Global Edition
Problem 17-19 (continued)
f. Cash + Marketable securities
+ Accounts receivable + Short-term notes
Acid-test ratio=
Current liabilities
Cash + Marketable securities
+ Accounts receivable + Short-term notes
= =1.12
$250,000

Cash + $0 + $200,000 + $0 = $250,000 × 1.12 = $280,000

Cash = $80,000

g. Current assets
Current ratio=
Current liabilities
Current assets
= =2.4
$250,000
Current assets=$250,000 × 2.4=$600,000

Current assets = Cash + Accounts receivable + Inventory

$600,000 = $80,000 + $200,000 + Inventory

Inventory = $600,000 - $80,000 - $200,000 = $320,000

h. Cost of goods sold

Inventory turnover=
Average inventory

Cost of goods sold

=
($280,000 + $320,000)/2

Cost of goods sold

= = 6.0
$300,000
Cost of goods sold=$300,000 × 6.0=$1,800,000

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Solutions Manual, Chapter 17 1043
Problem 17-19 (continued)
i. Gross margin = $2,700,000 – $1,800,000 = $900,000

j. Net operating income = Gross margin – Selling & administrative expenses

$315,000 = $900,000 – Selling and administrative expenses

Selling and administrative expenses = $900,000 – $315,000 = $585,000.

k. The interest expense for the year was $45,000 and the interest rate was
10%, so the bonds payable must total $450,000.

l. Total liabilities = $250,000 + $450,000 = $700,000

Net income-Preferred dividends

Earnings per share =
m Average number of
. common shares outstanding

$162,000
=
Average number of
common shares outstanding

= $4.05 per share

Average number of = $162,000 ÷ $4.05 per share

common shares outstanding

= 40,000 shares
The stock is $2.50 par value per share, so the total common stock must
be $100,000.

n.
Total liabilities $700,000
Debt-to-equity ratio = = =0.875
Total equity Total equity

Total equity = $700,000 ÷ 0.875 = $800,000

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1044 Managerial Accounting, Asia Global Edition
Problem 17-19 (continued)

o. Total equity = Common stock + Retained earnings

$800,000 = $100,000 + Retained earnings
Retained earnings = $800,000 − $100,000 = $700,000

p. Total assets = Total liabilities + Total equity

Total assets = $700,000 + $800,000 = $1,500,000.

This answer can also be obtained through the return on total assets ratio:

Return on = Net income + [Interest expense × (1-Tax rate)]

total assets Average total assets

$162,000 + [$45,000 × (1 - 0.40)]

=
Average total assets

$189,000
= = 14.0%
Average total assets

Average total assets = $189,000 ÷ 0.14 = $1,350,000

Therefore the average total assets must be $1,350,000. Since the total
assets at the beginning of the year were $1,200,000, the total assets at
the end of the year must have been $1,500,000 (which would also equal
the total of the liabilities and the equity).

q. Total assets = Total current assets + Plant and equipment

$1,500,000 = $600,000 + Plant and equipment
Plant and equipment = $1,500,000 − $600,000 = $900,000

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Solutions Manual, Chapter 17 1045