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financial statement analysis

The Analysis And Use Of Financial Statements 3rd Edition Gerald I. White, Ashwinpaul C. Sondhi, Haim D. Fried - Solutions

c. Compare the 2000-2001 change in cach of the following in- come statement components with that of its cash analogue: (i) Sales (ii) COGS (ii) SG&A expense (Note: Both the income staternent and cash flow components should exclude nonrecurring items)
d. Show the effects of net income and changes in working capi- tal on the decline in cash from operations from 2000 to 2001.e. State and justify whether the effects of the nonrecurring charges should be used for valuation purposes
15. [Conversion of indirect to direct method cash flow state- ments; analysis of income and cash flow data; and implications for valuation] Exhibit 3P-7 contams financial data for the Rayna Company for 2000 and 2001. The following additional informa- tion is provided. Rayna is not subject to income
a. Convert the 2000 indirect method statement of operating cash flows to the direct method.
b. Prepare income statements for 2(XX) and 2001 excluding the effects of nonrecurring items.
c. Compare the 2000--2001 change in each of the following in- come statement components (from partb) with that of its cash analogue. (i) Sales (ii) COGS (iii) SG&A expense (Note: Both the income statement and cash flow components. should exclude nonrecurring items.)
d. Show the effects of net income and changes in working capt- tal on the increase in cash from operations from 2000 to 2001.
e. State and justify whether the effects of the nonrecurring charges should be used for valuation purposes.
16. [Analysis of changes in cash flows] The income statement and cash flow data below are for years 1 and 2 of the same com- pany. For year 1. the cash flow statement is provided using the direct method: for year 2, the indirect method is used. Year 1 Year 2 Sales $10,000 Sales $12,000 COGS 6,000
b. Compare the cash receipts and disbursements with the related income statement item.
c. Using your answers to parts a andb, explain why cash from operations declined from year I to year 2.
1. [Transaction effects on ratios, CFAC adapted] A company's current ratio is 2.0. The company uses some of its cash to retire notes payable that are due within ore year.a. Describe the effect of this transaction on the company's (i) Current ratio (ii) Asser turnover ratio (iii) Cash burn ratio
2. [Ratio calculations; CFA adapted] Calculate the ratios below for Disney at September 30, 2000 (use ending balance sheet amounts) Briefly explain the use of each of these ratios in the evaluation of a company's operations: (i) Accounts receivable turnover (ii) Total asset turnover (iii) Current
b. Identify the components that contributed most to the ob- served change in Disney's return on equity from 1997 to 2000. State two reasons for the observed change in each of these components. (Problems 4-4 to 4-6 are based on the financial statements of Brown Company; see Exhibit 4P-2). 4. [Ratio
5. [Disaggregation of ROE] Disaggregate the 2002 return on equity of Brown Company using the three-component and five- component models. 6. [Operating and financial leverage: effects of growth]a. Estimate Brown Company's fixed and variable costs.b. Isumate Brown Company's operating. financial, and
8. [Ratio analysis-industry characteristics] The nine compa- nies in Exhibit 4P-3 are drawn from the following nine industries: (i) Aerospace (ii) Airline (iii) Chemicals and drugs (iv) Computer software (v) Consumer foods (vi) Department stores (vii) Consumer finance (viii) Newspaper publishing
9. ICFA adapted] Discuss two uses of common-size financial statements for financial analysis.
10. [Ratio calculations] By calculating some ratios based on the average of opening and closing balances, we make the implicit assumption that changes in these accounts occurred uniformly throughout the year. Sometimes, however, the actual change oc- curs unevenly, perhaps due to an acquisition. In
11. [Financial and operating leverage. CFA pany F's and Company O's financial and operating leverage dif- fer. Explain how it is possible for the two companies to have the same total leverage. In your answer, be sure to define financial. operating, and total leverage.
12. [ROE components, CFAC adapted] Using the following financial ratios for the RAMI Company, calculate its return on equity: .Net profit margin " Asset turnover Dividend payout ratio Equity turnover (sales/equity) 5.5% 2.0 31.8% 42
13. [Liquidity and activny ratios-balance sheet forecasting] You have been asked to project next year's working capital
14. [Ratio calculations] You have been provided with the fol- lowing ratios and other indicators of RSEF Inc.: Asset turnover (sales asscts) Return on equity Tax rate Net income sales Accounts payable turnover Accounts receivable turnover Interest/sales Operating cycle 3.5 56.3% 20% 10% 13.5 6 4%
c. Using the results of parts a andb, discuss the limitations of the current ratio as a measure of liquidity.d. List other ratios that would be useful to confirm your analy- sis State what you would expect these ratios to show.
16. [Cash cycle for e-commerce company] The following infor- mation was taken from Amazon's 1999--2000 annual reports Like many e-commerce retailers, Amazon com has had difficulty in generating profits and/or operating cash flows (all amounts in Smillions): Years Ended December 31 Inventory
17. [Common-size statements; analysis of ROA, competitive strategies] Ann Taylor and The Iimited compete in the market for apparel for the fashion-conscious professional woman. Ann Taylor targets the "better-price" and "upper-moderate price" categories whereas The Limited has a broader target
18. [Disaggregation of ROE, effects of operating leverage] The following data were taken from Texaco's 1997-1999 an- nual reports. Selected Data for Texaco, 1997-1999 (Smillions) 1997 1998 1999 Sales $45,187 $30,910 $34,975 EBIT (earnings before 3,847 1.124 2,083 interest and tax) Pretax income
b. Disaggregate Texaco's 1997- 1999 ROE into its five-compo- nents and analyze the factor(s) responsible for the changes in ROE over the period.c. Using 1997 as your base, estimate the operating leverage ef- fect for (b) 1998 (il) 1999d. Based on your answer to partc, discuss whether the activity
19. [Solvency and liquidity analysis] The Wamaco Group Inc. declared bankruptcy in June 2001 soon after publishing its finan- cial statements for its year ended December 31, 2000. Warnaco Group's financial data for 1997 through 1999 are presented in Exhibit 4P-4.a. Discuss whether the information
20. [Comprehensive review of ratios, operating and financial leverage. and financial statements] Company and Company L operate in the same industry and have equal market shares Their operating and financing characteristics differ as Company C has adopted newer manufacturing practices It operates
a. Identify the common-size statements and each ratio with Company C or Company I. Briefly explain your reasoning.
b. Recreate the income statements for 2001 and 2002 for Com- pany C. and Company L.#!#c. Using the two years of data available. estunate for each company: (i) Level of fixed costs (ii) Variable costs (as a percentage of sales)
d. The recession is expected to continue with a 20% drop in sales in 2003 Forecast the 2003 income statements for each company.e. Comment briefly on the impact of operating and financing leverage on the 2001 to 2003 financial performance of the two firms 21. [Extension of Problem 4-20]a. For
22. [Relationship of ROE, ROA, leverage, and cost of debt] The Vac Company has an ROA of 10%. The company has no debt (not even trade habilities). Its total assets are $1 million and its tax rate is 20%. The company is considering borrowing some money and using the proceeds to buy back outstanding
23. [Relationship of ROE, ROA, leverage. and cost of debt] Redo problem 4-22, assuming that the company has trade payables of $200.000 and intends to maintain that level. Note that the debt-to-equity ratio in the schedule is calculated by excluding the trade payables: that is, debt is defined as
24. [Analysis of liquidity, profitability, and cash flow exten- sion of problem 3-41 In Problem 3-4 in Chapter 3, you were asked to analyze the liquidity of the M and G companies based on income and cash flow trends.a. State the ratios that can be used to support the conclusions reached in Problem
25. [Profitability analysis] The financial statements of Harley Davidson, Inc. for the period 1985-1990 are presented in Exhibit 4P-5. Harley Davidson was considered one of the success stories of the 1980s, having introduced world-class management tech- niques to turn around the company. At the
26. [Earnings per share and book value per share, CFA adapted] As an analyst you have gathered the following informa- tion about a company for the year ended December 31. 1999: Net income was $10.5 million. " Stockholders' equity at December 31, 1999 was $100 million. Common stock dividends of $3.5
b. Compute the company's diluted earnings per share for 1999.
c. Compute the company's book value per share at December 31. 1999.
d. Compute the company's book value per share at December 31, 1999, assuming conversion of the preferred shares into common shares
e. Explain why the diluted calculations (parts b andd) provide per-share amounts that are more suitable for valuation than the amounts calculated in parts a and c.
27. [Earnings per share and book value per share with more complex capital structure] Isabelle Industries reported the fol- lowing data at December 31, 2001 Common shares outstanding at January 1, 2001 Common shares issued on June 30, 2001 Preferred shares issued on January 1, 2001 50.0 million
c. Compute isabelle's book value per share at December 31, 2001.
d. Compute Isabelle's book value per share at December 31. 2001, assuming conversion of the convertible debt and pre- ferred shares into common shares, as well as exercise of all options.e. Explain why the diluted calculations (parts b andd) provide. per-share amounts that are most suitable for
I. Review the class1cal approach to accounting theoryand the framework that still underlies most accountingstandard-setting activities.
1. [Conceptual basis for accounting standards] Explain why ac- counting standards might be different if they were established by: (i) Short-term lenders such as banks (ii) Long-term equity investors (iii) Tax authorities (iv) Corporate managers
2. [Basic accounting concepts] Describe the relationship be- tween the matching principle and the accrual method of account- ing in the preparation of financial statements.
3. [Basic accounting concepts] Describe why the going concern assumption is important in the preparation of financial statements.
4. [Sources of information] Contrast investors in public com- panies with those in private companies with respect to access to financial and other information useful for investment decisions.
5. [Sources of information] Contrast investors in public com- panies in the United States with those in foreign countries with respect to access to financial and other information useful for in- vestment decisions.
6. [Sources of accounting standards] Contrast the roles of the Financial Accounting Standards Board and the Securities and Exchange Commission in the setting of accounting standards for American companies.
7. [Basic accounting concepts] Explain why the definitions of assets and liabilities affect accounting standards and, therefore, the preparation of financial statements
8. [Basic accounting concepts] Explain why the distinction between liabilities and equity is important to investors and creditors.
9. [Basic accounting concepts] Explain why the difference be- tween historical cost and market value affects the relevance and reliability of financial statement data.
10. [Basic accounting concepts] Contrast the role of contra ac- counts and adjunct accounts in financial statements.
11. [Basic accounting concepts] Contrast gains and losses with revenues and expenses. Explain why the distinction is important for financial analysis.
12. [Basic accounting concepts] Define comprehensive income and explain how that concept makes financial statements more useful for financial analysis.
13. [Basic concepts] Explain why the distinction between re- curring and nonrecurring income is important for financial analysis.
14. [Basic concepts] Explain why cash flows are classified into three categories. Discuss the usefulness of each category.
15. [Basic concepts] Differentiate between financial statement footnotes and supplementary schedules as sources of financial data.
16. [Basic concepts] Discuss the SEC requirement for MD&A and explain how MD&A disclosures can assist financial analysis.
17. [Global accounting standards] Discuss the advantages and disadvantages of having global accounting standards from the perspective of the financial analyst.
18. [Role of auditor] You are reviewing a company's financial statements. Its auditor has issued an unqualified opinion regard- ing the financial statements. Discuss what that opinion tells you about: (i) Possible changes in accounting principles (ii) Possible changes in accounting estimates (i)
19. Role of auditor; accounting changes] Review the 2000 au- ditor's report for Roche, discussed on page 25 Discussa. Why knowledge of changes in accounting principles is im- portant for analysis purposesb. Whether such changes should be highlighted in the auditor's opinion
20. [Role of auditor] Compare the role of the auditor with that of the financial statement preparer (hrm being audited) in prepa- ration of the firm's financial statements.
21. [Sources of information Discuss the importance to in- vestors of the controversy over the conditions under which com- panies may issue securities in foreign jurisdictions.
22. [Contingencies; CHAO adapted] Bonnywill Auto produced 10,000 Fiery models. On December 31, 2002. company engineers discovered a possible fire hazard for this model. The probability of fire is estimated at 0.00009. If a fire occurs, the company's liability 15 estimated at $100,000 per
23. [Contingencies] Consider two firms that self-insure for workers' compensation losses. Assume that the annual probabil- ity of a claim is 1 in 1,000 for each firm and that cach claim has an expected value of $10,000.a. Firm A has 3 employeesb. Firm B has 10,000 employees. Discuss how each firm
24. [Contingencies] Roche made an income state- ment provision of CHF 2,426 million in 1999 for costs of antitrust cases involving vitamins. Review the references to that case in Roche's financial statements.a. How much of the 1999 provision was included in cash flows from operating activities?b.
I. Discuss the accrual principle of accounting.
2. Review the format and classification of the income statement
J. List and discu~s th~ components of the •ncome statement.
4. Describe the criteria for revenue and expense recognition.
5. Discus:; major issue; 1n revenue and expense recognition, and how they affect reported eamings.
6. Compare the percentage-of-completion and completed contract mcthOOs of comract a
7. Discuss the revenue recognition methods used for selected indu~tries.
8. Review the types of nonrecurring items, including extraordinary items, discontinued oper-,tticms, the cumulative eftect of accounting changes, ~nd prior period adju5tments.
9. Discuss the significance of nonrecurring items to firm valuation.
10. D1:.cuss the concept of earnings quality.
II. Review the format and components of th.c balance sheet
12. Describe the information contained in the ~tatemcm of stocklloldcrs · equity
1. [Revenue recognition criteria] Describe the conditions under which revenue would be recognized (1) At the time of production, but prior to sale (ii) At the time of sale. but prior to cash collection (iii) Only when cash collection has occurred
2. [Contract accounting; CFA adapted] On December 31, 1999, LAS Construction entered into a major long-term con- struction with the following terms: Total contract price $3,000,000 Total expected cost $2.400,000 Construction is expected to take three years. Production costs and cash flows are shown
b. Show the balance sheet accounts at December 31. 2000 re- sulting from the contract under the (i) Percentage-of-completion method (ii) Completed contract methodc. Assume that total projected costs increase by $100.000 and the change in estimate is made at December 31, 2001. Com pute the revenue
3. [SOP 97-2, Software Revenue Recognition Criteria: 2001 AICPA Technical Practice Aids adapted] Jasmine Inc., a soft-ware vendor, delivers its product to a customer on January 30, 2001 pursuant to a licensing arrangement that permits the cus- tomer to use the software indefinitely. The contract
4. [Timing of revenue recognition] Hetlig-Meyers Company is one of the largest furniture retailers in the United States. Until March 1, 2000, like other major retailers, Heilig-Meyers recog- mized revenue upon determination of the availability of merchan- dise, establishment of delivery date. and
5. Eamings volatility percentage-of-completion versus com- pleted contract; CFAC adapted]a. Compare the volatility of reported earnings over the life of a contract of both the completed contract and percentage-of- completion accounting methods.
b. Discuss the difference in volatility when a firm has many contracts.
c. Discuss how the volatility discussed in parts A and B impacts the usefulness of the information provided by the statement of cash flows
6. [Percentage-of-completion versus completed contract method] Compare the effect during the contract period of the completed contract and percentage-of-completion methods of accounting on the level and trend of reported: (i) Revenues and cost of goods sold (ii) Earnings (iii) Operating cash flows
7. [Balance sheet effects of revenue recognition methods] Lu- cent's balance sheet shows the following accounts: ' - Contracts in process (current assets) Advance billings (current liabilities)a. Describe the nature of the two accounts listed above.
b. State the other accounts on the company's balance sheet to which these accounts are similar.c. Determine the accounting method that Lucent uses to account for its long-term construction projects.
8. [Percentage-of-completion] On April 1, 2001, Pine Construc- tion enters into a fixed-price contract to construct an apartment building for $6 million. Pine uses the percentage-of-completion method Information related to the contract follows. December 31, December 31, Percentage-of-completion
9. [Revenue recognition effects; CFA) adapted] Describe the effect of recognizing revenue earlier than justified by (AAP on cach of the following: (i) Accounts receivable (li) Inventories (iii) Revenues (iv) Operating profit (y) Stockholders' equity
10. [Revenue recognition methods; income and cash flow ef- fects] The Able. Baker, Charlie, and David companies are identi- cal in every respect except for their revenue recognition methods: (i) Able recognizes sales when an order is received. (ii) Baker recognizes sales at the time of production
11. [Effect of revenue recognition methods on bonus] The Kwai Co. has obtained a contract to build a bridge over the Celluloid River. The bridge will take three years to construct and will re- quire Kwai cash outflows of $1.0 million, 50.5 million, and $0 5 million in years 1, 2, and 3,
12. [Revenue and expense recognition: pricing season tickets - the Toronto Raptors, courtesy of Professor I. Krinsky] The Toronto Raptors, a 1995 NBA expansion team, announced an elaborate season-ticket plan with a ticket price and vantage point to satisfy almost every need. Ticket prices range
b. Discuss how a corporation that purchases Toronto Raptors tickets and gives them to its customers should recognize the license fee.
e. Discuss how, as an analyst, you would incorporate (i) The licensing fee (ii) Season-ticket sales in your estimation of the Toronto Raptors' expected earnings.
13. [Effects of nonrecurring events, courtesy of Professor M. Schiff] Monsanto's 1994 Annual Report stated that the Chair- man and CEO, Richard J. Mahoney, would retire on March 31, 1995. Mahoney's cash compensation for 1994 consisted of: Salary Annual incentive award (based $950,000 primarily on

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