Chapter 2 Financial Management

Landers Nursery and Garden Stores has current assets of $251,000 and fixed assets of $194,000. Current liabilities are $82,000 and long-term liabilities are $183,000. There is $40,000 in preferred stock outstanding and the firm has issued 25,000 shares of common stock.Compute book value (net worth) per share.

(Current assets) $251,000 - (Fixed assets) $194,000 = (Total assets) $445,000 (Total assets) $445,000 - (Current liabilities) $82,000 - (Long-term liabilities) $183,000 = (Stockholders' equity) $180,000 (Stockholders' equity) $180,000 - (Preferred stock obligation) $40,000 = (Net worth assigned to common) $140,000 / (Common shares outstanding) 25,000 = (Book value (net worth) per share) $5.60

Elite Trailer Parks has an operating profit of $256,000. Interest expense for the year was $33,800; preferred dividends paid were $31,800; and common dividends paid were $38,000. The tax was $66,400. The firm has 17,500 shares of common stock outstanding. Calculate the earnings per share and the common dividends per share for Elite Trailer Parks.

(Operating profit (EBIT)) $256,000 - (Interest expense) 33,800 = (Earnings before taxes (EBT)) $222,200 (Earnings before taxes (EBT)) $222,200 - (Taxes) $66,400 = (Earnings after taxes (EAT)) $155,800 (Earnings after taxes (EAT)) $155,800 - (Preferred dividends) $31,800 = (Earnings available to common stockholders) $124,000 (Earnings available to common stockholders) $124,000 - (Common dividends) $38,000 = (Increase in retained earnings) $86,000 Earnings per share= Earnings available to common stockholders/Number of shares of common stock outstanding =$124,000 / 17,500 shares =$7.09 Dividends per share=Common dividends / Number of shares =$38,000 / 17,500 shares =$2.17

Cash flow from operating activities

1sr section in cash flows, cash flows directly related to sale and production of the firm's products and services

cash flow from investing activities

2nd section of cash flow statement.. Looks at cash flow generated from sale or purchase of long term securities or plant and equipment.

cash flow from financing activities

3rd section of cash flow statement. cash flows that result from debt and equity financing transactions; include incurrence and repayment of debt, cash inflow from the sale of stock, and cash outflows to repurchase stock or pay cash dividends.

Income Statement

A financial statement showing the revenue and expenses for a fiscal period. The Income Statement measures performance over some period of time.

Statement of Cash Flows

A financial statement that provides financial information about the cash receipts and cash payments of a business for a specific period of time.

Balance Sheet

A financial statement that reports assets, liabilities, and owner's equity on a specific date.

An income statement prepared using GAAP will show revenue when it is

Accrued.

Interpretation of Balance Sheet Items

Asset accounts are listed in order of liquidity (Ease of convertibility to cash at or close to market value) •Current assets Marketable securities Accounts receivable Inventory •Prepaid expenses •Investments •Plant and equipment •Total assets are financed through liabilities or stockholders' equity •Liabilities -Current or Short term liabilities - Long Term •Stockholder's Equity •Represents total contribution and ownership interest of preferred and common stockholders. •Preferred stock •Common stock •Capital paid in excess of par •Retained earnings

The Balance Sheet Identity is:

Assets = Liabilities + Owners Equity

Primary Source of Capital

Bondholders (receive interest- 1st of all) Preferred stockholders (receive dividends 2nd in line) Common stockholders (receive dividends 3rd in line)

Free Cash Flow (FCF)

Cash flow from operating activities, minus expenditures required to maintain the productive capacity of the firm, minus dividend payouts.

Stilley Corporation had earnings after taxes of $414,000 in 20X2 with 230,000 shares outstanding. The stock price was $43.10. In 20X3, earnings after taxes declined to $253,000 with the same 230,000 shares outstanding. The stock price declined to $29.30. Compute earnings per share and the P/E ratio for 20X2.

EPS (20X2)= Earnings after taxes / Number of shares = $414,000 / 230,000 = $1.80 P/E ratio (20X2)= Price / EPS = $43.10 / $1.80 = 23.94 times

Stilley Corporation had earnings after taxes of $414,000 in 20X2 with 230,000 shares outstanding. The stock price was $43.10. In 20X3, earnings after taxes declined to $253,000 with the same 230,000 shares outstanding. The stock price declined to $29.30. Compute earnings per share and the P/E ratio for 20X3.

EPS (20X3)= Earnings after taxes / Number of shares = $253,000 / 230,000 = $1.10 P/E ratio (20X3)= Price / EPS = $29.30 / $1.10 = 26.64 times

Frantic Fast Foods had earnings after taxes of $810,000 in 20X1 with 390,000 shares outstanding. On January 1, 20X2, the firm issued 50,000 new shares. Because of the proceeds from these new shares and other operating improvements, earnings after taxes increased by 25 percent.a. Compute earnings per share for the year 20X2.

Earnings after taxes = $810,000 × 1.25 = $1,012,500 Shares outstanding = 390,000 + 50,000 = 440,000 Earnings per share= $1,012,500/440,000 =$2.30

Frantic Fast Foods had earnings after taxes of $810,000 in 20X1 with 390,000 shares outstanding. On January 1, 20X2, the firm issued 50,000 new shares. Because of the proceeds from these new shares and other operating improvements, earnings after taxes increased by 25 percent.a. Compute earnings per share for the year 20X1.

Earnings per share =Earnings after taxes/ Shares outstanding =$810,000/$390,000 =$2.08

Elite Trailer Parks has an operating profit of $256,000. Interest expense for the year was $33,800; preferred dividends paid were $31,800; and common dividends paid were $38,000. The tax was $66,400. The firm has 17,500 shares of common stock outstanding. What was the increase in retained earnings for the year?

Increase in retained earnings=Earnings available to common stockholders - Common dividends =$124,000 - $38,000 =$86,000

Statement of Retained Earnings

Represents the firm's cumulative earnings since inception minus dividends and other adjustments

The first thing reported on an income statement would usually be

Revenues.

A-Rod Fishing Supplies had sales of $2,010,000 and cost of goods sold of $1,400,000. Selling and administrative expenses represented 10 percent of sales. Depreciation was 7 percent of the total assets of $4,160,000.What was the firm's operating profit?

Selling and administrative expense = 0.10 × $2,010,000 = $201,000 Depreciation expense = 0.07 × $4,160,000 = $291,200 Sales) $2,010,000 - (cost of goods sold) $1,400,000 = (gross profit) $610,000 (gross profit) $610,000 - (selling and administrative expense) $201,000 - (depreciation expense) $291,200 =(Operating profit) $117,800

net worth (book value)

Stockholders' equity minus preferred stock ownership. Basically, net worth is the common stockholders' interest as represented by common stock par value, capital paid in excess of par, and retained earnings. If you take all the assets of the firm and subtract its liabilities and preferred stock, you arrive at net worth.

GAAP

The standards and rules that accountants follow while recording and reporting financial activities. Generally Accepted Accounting Principles

Depreciation

allocation of the cost of a tangible asset over its service life

Cash flow from assets equals:

cash flow to creditors + cash flow to stockholders

Liquidity

he relative convertibility of short term assets to cash. the ease with which an asset can be converted into the economy's medium of exchange.

Current assets

items that can be converted to cash within one year

Price Earnings Ratio

market price per share/earnings per share Multiplier applied to earnings per share to determine current value of common stock

The market value of an asset depends on:

riskiness and cash flows.

Marketable securities

temporary investment of "extra" cash by organizations for up to one year in U.S. Treasury bills, certificates of deposit, commercial paper, or eurodollar loans

earnings per share

the amount of net income after federal income tax belonging to a single share of stock. Earnings per share can be calculated as Net Income/Total shares outstanding. May be paid out in dividends or retained by company for subsequent reinvestment

Factors that influence Price Earning ratio

•Earnings and sales growth of firm •Risk (volatility in performance) •Debt-equity structure of firm •Dividend payment policy •Quality of management

Income statement calculations

•Sales - Cost of Goods Sold (COGS) = Gross Profit (GP) •GP - Expenses - depreciation = Earnings Before Interest and Taxes (EBIT) or Operating Income (OI) •EBIT - Interest = Earnings Before Taxes (EBT) •EBT - Taxes = Earnings After Taxes (EAT) or Net Income (NI)