Financial Accounting: An Integrated Statements Approach, 2nd Edition

EXERCISES

660 Chapter 14 Financial Statement Analysis

5. What is the DuPont formula?


6. A company that grants terms of n/30 on all sales has a
   yearly accounts receivable turnover, based on monthly
   averages, of 6. Is this a satisfactory turnover? Discuss.


7. What does an increase in the number of days’ sales in re-
   ceivables ordinarily indicate about the credit and collec-
   tion policy of the firm?


8. a. Why is it advantageous to have a high inventory
   turnover?
   b.Is it possible for the inventory turnover to be too
   high? Discuss.


9. Would a railroad be expected to have a high fixed asset
   turnover?


10. a.What is financial leverage?
    b.What impact does positive leverage have on the rate
    earned on stockholders’ equity compared to the rate
    earned on total assets?


11. How would the current and quick ratios of a service busi-
    ness compare?


12. For Lindsay Corporation, the working capital at the end
    of the current year is $5,000 greater than the working cap-
    ital at the end of the preceding year, reported as follows:

Current Year Preceding Year

Current assets:

Cash, marketable securities,

and receivables $34,000 $30,000

Inventories 51,000 32,500

Total current assets $85,000 $62,500

Current liabilities 42,500 25,000

Working capital $42,500 $37,500

Has the current position improved? Explain.

13. What do the following data taken from a comparative
    balance sheet indicate about the company’s ability to bor-
    row additional funds on a long-term basis in the current
    year as compared to the preceding year?

Current Year Preceding Year

Fixed assets (net) $175,000 $170,000

Total long-term liabilities 70,000 85,000

14. What does a decrease in the ratio of liabilities to stock-
    holders’ equity indicate about the margin of safety for a
    firm’s creditors and the ability of the firm to withstand
    adverse business conditions?


15. The price-earnings ratio for the common stock of Benoit
    Company was 10 at December 31, the end of the current
    fiscal year. What does the ratio indicate about the sell-
    ing price of the common stock in relation to current
    earnings?


16. Why would the dividend yield differ significantly from
    the rate earned on common stockholders’ equity?


17. Favorable business conditions may bring about certain
    seemingly unfavorable ratios, and unfavorable business
    operations may result in apparently favorable ratios. For
    example, Sanchez Company increased its sales and net
    income substantially for the current year; yet, the current
    ratio at the end of the year is lower than at the beginning
    of the year. Discuss some possible causes of the apparent
    weakening of the current position, while sales and net in-
    come have increased substantially.


18. Indicate the purpose of the Management Discussion and
    Analysis in a corporation’s annual report.

Revenue and expense data for Home-Mate Appliance Co. are as follows:

2007 2006

Sales $500,000 $450,000

Cost of goods sold 275,000 234,000

Selling expenses 90,000 94,500

Administrative expenses 60,000 63,000

Income tax expense 25,000 22,500

a. Prepare an income statement in comparative form, stating each item for both 2007 and

2006 as a percent of sales.

b. Comment on the significant changes disclosed by the comparative income statement.

The following comparative income statement (in millions of dollars) for the fiscal years 2003

and 2004 was adapted from the annual report of Speedway Motorsports, Inc., owner and op-

erator of several major motor speedways, such as the Atlanta, Texas, and Las Vegas Motor

Speedways.

Exercise 14-1

Vertical analysis of income

statement

Goal 1

2007 net income: $50,000;

10% of sales

Exercise 14-2

Vertical analysis of income

statement