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ADMS 2500 (62)
Chapter

module_15_solutions.pdf

6 Pages
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School
York University
Department
Administrative Studies
Course
ADMS 2500
Professor
Rebecca Jubis
Semester
Winter

Description
Financial Statement Analysis Practice Problems Solutions PROBLEM 1 – MULTIPLE CHOICE 1. d Explanation: Note: Keep the balance sheet equation in mind when doing these types of problems. Assets = Liabilities + Equity a) Collects accounts receivable - Has no affect on ratio, because a current asset increases (cash) and a current asset decreases (accounts receivable) by the same amount, so no affect on equity and the debt/equity ratio. Assets = Liabilities + Equity Equity = Assets - Liabilities Equity = Assets (↑and↓ by the same amount) – Liabilities So no change in the equation and no affect on the ratio b) Borrows cash giving a short-term note payable – Will not change the ratio, because borrowing cash will increase current assets and current liabilities by the same amount, thus no affect on equity or long-term liabilities. Equity = Assets - Liabilities Equity = Assets (↑by the same amount as liabilities) – Liabilities (↑by the same amount as assets) So no change in equity, but and increase in total debt causes an increase in the ratio c) Purchases land for cash – Has no affect on ratio, because an asset increases (land) and an asset decreases (cash) by the same amount, so no affect on equity and the debt/equity ratio. Assets = Liabilities + Equity Equity = Assets - Liabilities Equity = Assets (↑and↓ by the same amount) – Liabilities So no change in the equation and no affect on the ratio d) Issues stock for cash – Will decrease the ratio, becaus e issuing stock will increase an asset (cash) and increase and equity account (stock). This has no affect on total debt, but increases equity, thus causing a decrease in the debt/equity ratio. Equity = Assets - Liabilities Equity (↑by the same amount as assets) = Assets (↑by the same amount as equity) – Liabilities So increase in equity, but and no increase in total debt causes an decrease in the ratio 2. e Explanation: See explanation above. 3. b Explanation: a) declaring a cash dividend – Will decrease the ratio, because declaring a dividend will increase a current liability (dividend payable) and decrease and equity account (retained earnings). This has no affect on current assets, thus causing a decrease in the current ratio. b) issuing long-term debt - Will increase the ratio, because a current asset increases (cash) with no affect on current liabilities, thus causing a increase in the current ratio. c) making a mortgage payment – Will decrease the ratio, because a current asset (cash) and a long-term liability (mortgage) decreases, with no affect on current liabilities, thus causing a increase in the current ratio. d) collecting an accounts receivable - Has no affect on ratio, because a current asset increases (cash) and an current asset decrease (accounts receivable) by the same amount, so no affect on the current ratio. 4. c Explanation: The issuing of shares for cash and repaying half of the mortgage has no affect on average assets. This is because issuing shares increases assets, but using the cash received from issuing the shares to repay a portion of the mortgage decrease assets by the same amount, thus having no affect on average assets. Since EBITA is a earnings performance measure that ignores interest, EBITA will also be unchanged and the ratio EBITA/average assets will remain unchanged. 5. c Explanation: a) would not maximize the return to shareholders, as no return would be seen for 2 years. b) would dilute the shareholders return. c) would maximize the return to shareholders, as it has a minimal affect (assuming low interest rate on the borrowed funds). 6. c Explanation: The key to this question is attention to detail and understanding the classifications between, current and long term assets and liabilities. That said the following should be clear. Current Ratio = Current Assets Current Liabilities x = the balance in the Allowance for Uncollectible Accounts 2 = \$4,000 + \$13,000 + \$x + \$6,600 + \$600 1 \$2,000 + \$5,500 + \$500 + \$4,000 2 = \$24,200 + \$x 1 = \$12,000 2(\$12,000) = 1(\$24,200 + \$x) \$24,000 = \$24,200 + \$x \$x = \$24,000 - \$24,200 \$x = -\$200 The negative value represents a credit balance in the allowance for doubtful accounts. 7. a Explanation: Liquidity ratios measures the company’s short-run ability to pay its current and maturing obligations. 8. d Explanation: All of the above are inherent limitations of using financial statement data for ratio analysis. 9. c Explanation: The Return on Sales ratio in not a liquidity ratio. It is a profitability ratio. PRACTICE PROBLEM 2 Part (a) RATIO FO/URSMEULAPURPOSE Operating Performance Return on Sales Net Income Measures net income generated by Net Sales each dollar of sales Return on Assets Operating Income Measures overall profitability on assets Average Total Assets – Operating income is income before interest Return on Common Share Equity Net Income – Preferred Dividends Measures profitability on owners’ Average Common Shareholders’ Equity investment Earnings per Share Net Income – Preferred Dividends Requirement Measures net income earned on each Average Number of Common Shares Outstanding common share Price Earnings Ratio Market Price per Common Share Measures the ratio of the market price Earnings per Share per share to earnings per share Dividend Yield Common Dividends per Share Market Price per Share Dividend Payout Ratio Common Dividends per Share Measures the % of common share Earnings per share earnings paid out in dividends Financial Strength Equity Ratio Common Shareholders’ Equity Indication of financial structure Total Assets Preferred Dividend Coverage Operating Income Measures ability to meet dividend Annual Bond Interest + Preferred Dividends Requiremenpayments Bond Interest Coverage Operating Income Measures ability to meet interest Annual Bond Interest payments as they come due Working Capital Position Working Capital Turnover Sales Measures how efficiently current Working Capital assets net of current liabilities are being used to generate sales Current Ratio
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