Accounting Topic 3

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A transaction in which the present top management of a publicly held firm buys the stock of the nonmanagement stockholders and the firm becomes "privately owned" is known as a(n) Blank______.

leveraged buyout

Because firms within a given industry may vary considerably over time in terms of their Blank______, it is difficult to develop reliable rules of thumb for the evaluation of ratio results.

life cycle stage of development cost and capital structures relative scale of operations

To calculate the days' sales in accounts receivable, you divide the ______(beginning/ending/average) accounts receivable by the average day's ________(sales/cost of goods sold).

Blank 1: ending Blank 2: sales

The ______ (pre/after) -tax cost of debt is its interest rate multiplied by the complement of the firm's tax rate.

after

A company desiring to increase its total asset turnover could do so by using:

an accelerated depreciation method and the LIFO cost flow assumption.

Financial leverage:

arises because most borrowed funds have a fixed interest rate.

The following information was available for the year ended December 31, 2022: Earnings before interest and taxes (operating income)$ 50,000Interest expense10,000Income tax expense12,000Net income28,000Total assets at year-end200,000Total liabilities at year-end120,000 The debt ratio at December 31, 2022 was:

debt ratio=total liabilities/total liabilities and stockholders equity

The comparison of activity measures of different companies is complicated by the fact that:

different inventory cost flow assumptions may be used.

Another term for the price/earnings ratio is:

earnings multiple

Dividends that are stable, or gradually changing, and periodic in nature are known as Blank______ dividends.

regular

Because firms within a given industry may vary considerably over time in terms of their Blank______, it is difficult to develop reliable rules of thumb for the evaluation of ratio results.

relative scale of operations cost and capital structures life cycle stage of development

Firm E had 30,000 shares of $100 par value and 8 percent cumulative preferred stock authorized, issued, and outstanding during Year 1 and Year 2 but did not pay any preferred or common stock dividends in either year. Net income was $1,000,000 in Year 1 and $1,200,000 in Year 2. What is Firm E's preferred dividend coverage ratio for Year 2 (rounded to one decimal)?

$1,200,000 / (30,000 x $100 x 8%) = 5.0 times

Sales for Year 1 and Year 2 amounted to $1,200,000 and $1,500,000, respectively. Plant and equipment was $700,000 at the end of Year 1 and $500,000 at the end of Year 2. The plant and equipment turnover for Year 2 (rounded to one decimal) was:

$1,500,000 / (($700,000 + $500,000) / 2) = 2.5 times

For Year 2, sales were $1,200,000 and cost of goods sold was $800,000. Inventories amounted to $90,000 at the end of Year 1 and $110,000 at the end of Year 2. The days' sales in inventory for Year 2 (rounded to one decimal) was:

$110,000 / ($800,000 / 365) = 50.2 days

Sales for Year 1 and Year 2 amounted to $500,000 and $600,000, respectively. Accounts receivable was $100,000 at the end of Year 1 and $120,000 at the end of Year 2. The days' sales in accounts receivable for Year 2 (rounded to one decimal) was:

$120,000 / ($600,000 / 365) = 73.0 days

Firm A's common stock has a par value per share of $1, market value per share of $90, earnings per share of $5, dividends per share of $2, and a book value per share of $60. What is Firm A's dividend payout ratio (rounded to one decimal)?

$2 / $5 = 40%

$2 / $90 = 2.2%

Sales for Year 2 were $2,400,000. Accounts receivable was $200,000 at the end of Year 1 and $300,000 at the end of Year 2. The accounts receivable turnover for Year 2 (rounded to one decimal) was:

$2,400,000 / (($200,000 + $300,000) / 2) = 9.6 times

Total liabilities were $200,000 at the beginning of the year and $240,000 at the end of the year. Stockholders' equity was $300,000 at the beginning of the year and $400,000 at the end of the year. What was the debt ratio at the end of the year (rounded to one decimal)?

$240,000 / ($240,000 + $400,000) = 37.5%

For Year 2, sales were $300,000 and cost of goods sold was $180,000. Inventories amounted to $20,000 at the end of Year 1 and $30,000 at the end of Year 2. The days' sales in inventory for Year 2 (rounded to one decimal) was:

$30,000 / ($180,000 / 365) = 60.8 days

Total liabilities were $330,000 at the beginning of the year and $300,000 at the end of the year. Stockholders' equity was $270,000 at the beginning of the year and $240,000 at the end of the year. What was the debt/equity ratio at the end of the year (rounded to one decimal)?

$300,000 / $240,000 = 125%

Cost of goods sold for Year 2 was $300,000. Sales for Year 2 were $600,000. Inventory was $40,000 at the end of Year 1 and $60,000 at the end of Year 2. The inventory turnover for Year 2 (rounded to one decimal) was:

$300,000 / (($40,000 + $60,000) / 2) = 6.0 times

Firm B's common stock has a par value per share of $1, market value per share of $72, dividends per share of $4, earnings per share of $8, and a book value per share of $64. What is Firm B's dividend payout ratio (rounded to one decimal)?

$4 / $8 = 50%

Firm C's common stock has a par value per share of $10, earnings per share of $6, dividends per share of $5, a book value per share of $69, and a market value per share of $80. What is Firm C's dividend payout ratio (rounded to one decimal)?

$5 / $6 = 83.3%

$5 / $80 = 6.3%

Cost of goods sold was $400,000 and $500,000 in Year 1 and Year 2, respectively. Sales for Year 2 were $1,000,000. Inventory was $60,000 at the end of Year 1 and $40,000 at the end of Year 2. The inventory turnover for Year 2 (rounded to one decimal) was:

$500,000 / (($60,000 + $40,000) / 2) = 10.0 times

Total liabilities were $650,000 at the beginning of the year and $600,000 at the end of the year. Stockholders' equity was $300,000 at the beginning of the year and $400,000 at the end of the year. What was the debt/equity ratio at the end of the year (rounded to one decimal)?

$600,000 / $400,000 = 150%

$72 / $8 = 9.0 per share

Sales for Year 2 were $800,000. Accounts receivable was $100,000 at the end of Year 1 and $150,000 at the end of Year 2. The accounts receivable turnover for Year 2 (rounded to one decimal) was:

$800,000 / (($100,000 + $150,000) / 2) = 6.4 times

Cost of goods sold for Year 2 was $600,000. Sales for Year 2 were $800,000. Plant and equipment was $300,000 at the end of Year 1 and $500,000 at the end of Year 2. The plant and equipment turnover for Year 2 (rounded to one decimal) was:

$800,000 / (($300,000 + $500,000) / 2) = 2.0 times

$90 / $5 = $18 per share

Firm D had 20,000 shares of $50 par value and 6 percent cumulative preferred stock authorized, issued, and outstanding during Year 1 and Year 2 but did not pay any preferred or common stock dividends in either year. Net income was $800,000 in Year 1 and $900,000 in Year 2. What is Firm D's preferred dividend coverage ratio for Year 2 (rounded to one decimal)?

$900,000 / (20,000 x $50 x 6%) = 15.0 times

Firm G's earnings before income taxes for the year was $140,000, income tax expense was $35,000, interest expense was $20,000, and net income was $105,000. What was Firm G's times interest earned for the year (rounded to one decimal)?

($140,000 + $20,000) / $20,000 = 8.0 times

Firm H's earnings before income taxes for the year was $180,000, cost of goods sold was $240,000, interest expense was $30,000, and income tax expense was $60,000. What was Firm H's times interest earned for the year (rounded to one decimal)?

($180,000 + $30,000) / $30,000 = 7.0 times

The following information was available for the year ended December 31, 2022: Sales$ 300,000Net income50,000Average total assets750,000Average total stockholders' equity500,000 Turnover for the year ended December 31, 2022 was:

0.4 turnover=sales/average assets

The following information was available for the year ended December 31, 2022: Sales$ 500,000Net income80,000Average total assets1,000,000Average total stockholders' equity640,000 Turnover for the year ended December 31, 2022 was:

0.5 turnover=sale/average assets

12.5% ROE=net income/average stockholder equity

16% margin=net income/sales

The following amounts were reported on the December 31, 2022, balance sheet: Retained earnings$ 140,000Buildings and equipment, net of accumulated depreciation150,000Accounts receivable38,000Common stock20,000Wages payable5,000Cash13,000Land60,000Accounts payable25,000Bonds payable90,000Merchandise inventory24,000 The current ratio at December 31, 2022 was:

16.0 price/earnings ratio: market price of common stock/earnings per share of common stock

The following information was available for the year ended December 31, 2022: Net sales$ 300,000Cost of goods sold210,000Average accounts receivable for the year15,000Accounts receivable at year-end18,000Average inventory for the year60,000Inventory at year-end70,000 The accounts receivable turnover for 2022 was:

20.0 accounts receivable turnover=sales/average accounts receivable

The following information was available for the year ended December 31, 2022: Earnings before interest and taxes (operating income)$ 30,000Interest expense5,000Income tax expense7,000Net income18,000Total assets at year-end100,000Total liabilities at year-end75,000 The debt/equity ratio at December 31, 2022 was:

300.0%. 75,000/30,000+5,000,+7,000+18,000

If a company's debt ratio was 25%, its debt/equity ratio would be:

33.33%.

The following information was available for the year ended December 31, 2022: Net sales$ 240,000Cost of goods sold160,000Average accounts receivable for the year10,000Accounts receivable at year-end12,000Average inventory for the year40,000Inventory at year-end50,000 The inventory turnover for 2022 was:

4.0 times inventory turnover= cost of goods sold/average inventories

8.0% ROI=net income/average total assets

Which statements are true regarding the price/earning (P/E) ratio?

An above-average P/E ratio often indicates that investors anticipate relatively favorable future developments, such as increased earnings per share or higher dividends per share. The P/E ratio should not be the sole, or even principal, consideration in an investment decision. Low P/E ratios usually indicate poor earnings expectations.

Which of the following statements are true regarding the price/earning (P/E) ratio?

Analysts sometimes use expected future earnings per share and the current market price in the calculation to evaluate the prospects for changes in the stock's market price. The P/E ratio is one of the most important measures used by investors to evaluate the market price of a firm's common stock. Diluted earnings per share is usually the denominator of the P/E calculation.

Financial leverage refers to the use of _____(debt/equity/revenues) to finance the assets of an entity.

Blank 1: debt

The use of an accelerated depreciation method and the LIFO inventory cost flow assumption will usually ______ (increase/decrease) a company's total asset turnover relative to using the straight-line method and FIFO.

Blank 1: increase

The P/E ratio is calculated by dividing the ____ (dividends/price/earnings) per share of common stock by the _____(dividends/price/earnings) per share of common stock.

Blank 1: price Blank 2: earnings

To calculate the plant and equipment turnover, you divide ______ (sales/cost of goods sold) by the _______(beginning/ending/average) plant and equipment.

Blank 1: sales Blank 2: average

What indicators help suppliers and creditors judge the liquidity of a company?

Current and recent payment experience of the firm Cash discounts availed by the firm for prompt payments made

Which of the following is (are) an example of a measure of leverage?

Debt/equity ratio.

Which statements are true regarding the price/earning (P/E) ratio?

Firms with high P/E ratios generally have strong investor confidence. A high P/E ratio usually means that investors expect the firm to have strong future earnings and dividend growth. Low P/E ratios usually indicate poor earnings expectations.

What indicators help suppliers and creditors judge the liquidity of a company?

How the company is portrayed in Dun & Bradstreet reports How promptly the company has been paying its current and recent bills Whether the company is taking all available cash discounts for prompt payment

Identify a true statement about a leveraged buyout.

In a leveraged buyout, the company goes heavily into debt to obtain the funds needed to buy the shares of the public stockholders.

Credit-rating firms gather and report data about which of the following?

Individual companies Industries Segments of the economy

The following information was available for the year ended December 31, 2022: Net sales$ 300,000 Cost of goods sold 210,000 Average accounts receivable for the year 15,000 Accounts receivable at year-end 18,000 Average inventory for the year 60,000 Inventory at year-end 70,000 The inventory turnover for 2022 was:

Inventory turnover = cost of goods sold/ average inventories 210,000/60,000=3.5 times

Which statements regarding financial leverage are true?

It can lead to bankruptcy if the firm cannot generate enough cash to make payments on the principal and interest of its loans. It adds risk to the operation of the firm. It can be arranged via debt and preferred stock, because of their fixed interest cost (or dividend rate).

Which of these statements regarding financial leverage are true?

It magnifies the return to the owners (ROE) relative to the return on assets (ROI). It adds risk to the operation of the firm.

The difference between the inventory valuation as reported under LIFO and the amount that would have been reported under FIFO is called the Blank______.

LIFO reserve

The ratios used to facilitate the interpretation of an entity's financial position and results of operations can be grouped into which four categories?

Liquidity Debt (or financial leverage) Profitability Activity

Why is operating income frequently substituted for net income in the calculation of ROI and ROE?

Operating income excludes the effects of discontinued operations and thus provides a more forward looking measure of the firm's profitability. Operating income excludes income tax expense, which varies from firm to firm based on country-specific tax rates.

Why is operating income frequently substituted for net income in the calculation of ROI and ROE?

Operating income is a more direct measure of the results of a firm's activities. Operating income excludes interest expense, which varies from firm to firm based on their capital structure decisions.

PRACTICE QUIZ

Which of the following statements are true regarding the price/earning (P/E) ratio?

The P/E ratio is sometimes referred to as earnings multiple. P/E ratios are shown in the stock listing tables of The Wall Street Journal. The P/E ratio is a measure of the relative expensiveness of a company's common stock.

How do debt and preferred stock provide financial leverage?

They have a fixed interest cost (or dividend rate). The interest on debt can be deducted as an expense, lowering income taxes.

Identify the true statements about extra dividends.

They may be declared and paid after an especially profitable year. They indicate to stockholders that they should not expect to receive the larger amount every year.

Identify the true statements about credit-rating firms.

They usually have a rating system and assign a credit risk value based on that system. They evaluate the common and preferred stock issues of publicly traded companies.

increase

The ratios used to facilitate the interpretation of an entity's financial position and results of operations can be grouped into four (4) categories:

liquidity, activity, profitability, and debt

Because firms within a given industry may vary considerably over time in terms of their Blank______, it is difficult to develop reliable rules of thumb for the evaluation of ratio results.

market segmentation strategies relative scale of operations selected accounting methods

The LIFO reserve:

may be disclosed in the notes to the financial statements.

Because firms within a given industry may vary considerably over time in terms of their Blank______, it is difficult to develop reliable rules of thumb for the evaluation of ratio results.

selected accounting methods relative scale of operations market segmentation strategies

Earnings multiple is another term used to describe the price/earnings ratio. This term merely reflects that:

the market price of stock is equal to the earnings per share multiplied by the P/E ratio.

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