DOC

# Solutions for chapter 2

By Lester Murray,2014-07-02 13:36
9 views 0
Solutions for chapter 2

Solutions for chapter 2

E24

2004

2004 Ending Retained Earnings 2004 Beginning Retained Earnings

or = + Revenues for 2004

2005 Beginning Retained Earnings Expenses for 2004

Dividends for 2004

(\$523) = (\$499) + \$1,383 X \$0

X = \$1,407

Expenses for 2004 are \$1,407.

2005

(\$758) = (\$523) + \$1,522 \$1,608 X

X = \$149

Dividends declared for 2005 are \$149.

2006

(\$596) = (\$758) + X \$1,550 \$5

X = \$1,717

Revenue for 2006 is \$1,717.

2004 2005 2006

Sales growth (%) .................................................... N/A 10.0% 12.8% Profits ...................................................................... (\$24) (\$86) \$ 167 Profits as a percentage of sales ............................. (1.7%) (5.7%) 9.7% Dividends................................................................. \$ 0 \$ 149 \$ 5 Dividends as a percentage of net income .............. N/A N/A 3.0%

The advertising agency had modest sales growth from 2004 to 2006. However, from 2005 to 2006, the Company was able to go from losses to a profit. Even though the Company had a loss in 2005 the Company paid a healthy dividend. Then in 2006, when the Company showed a profit, it virtually

1

eliminated the dividend. There is reason to be optimistic going forward. In 2006 the Company

was able to show a nice growth in its sales while at the same time showing a reduction in its

expenses.

E211

Income Statement

For the Year Ended

Lease revenue ........................................................................................ \$3,000

Expenses ................................................................................................ 2,500

Net income .............................................................................................. \$ 500

Statement of Stockholders’ Equity

For the Year Ended

Contributed Retained

Capital Earnings

Beginning Balance \$ 0 \$ 0

Stock Issue 6,000

Net Income 500

Cash Dividends _____ (800)

Ending Balance \$6,000 \$ (300)

Balance Sheet

As of

Assets

Cash ....................................................................................................... \$ 2,700

Land ....................................................................................................... 8,000

Total assets ............................................................................................ \$ 10,700

Liabilities & Stockholders’ Equity

Note payable........................................................................................... \$ 5,000

Contributed capital .................................................................................. 6,000

Retained earnings .................................................................................. (300)

Total liabilities & stockholders’ equity ..................................................... \$ 10,700

2

Statement of Cash Flows

For the Year Ended

Cash flows from operating activities:

Cash collections from customers .......................................... \$ 3,000

Cash payments for expenses ............................................... (2,500)

Net cash flow from operating activities ............................ \$ 500

Cash flows from investing activities:

Purchase of land ................................................................... \$ (8,000)

Net cash flow from investing activities ............................. (8,000)

Cash flows from financing activities:

Proceeds from equity investor .............................................. \$ 6,000

Proceeds from borrowing ...................................................... 5,000

Cash payments for dividends ............................................... (800)

Net cash flow from financing activities ............................. 10,200

Increase in cash ........................................................................ \$ 2,700

Beginning cash balance ............................................................ 0

Ending cash balance ................................................................. \$ 2,700

Upon examining George’s financial statements the bank would certainly be concerned because George paid out more in dividends than the net income he realized during the year. George’s

statement of retained earnings shows a negative balance, which means that the payment to equity investors which was disguised as return on capital was in fact a return of capital. Generally, dividend

payments cannot exceed the Retained Earnings balance.

P23

2005

Contributed Capital:

Total assets = Total liabilities + Total stockholders' equity

(\$300 + \$200 + \$500 + \$100 + \$700) = (\$200 + \$500) + (Contributed cap. + \$400)

Contributed capital = \$700

Net Income:

Net income = Sales Expenses

= \$1,000 \$400

= \$600

Dividends:

3

Ending retained earnings = Beginning retained earnings + Net income Dividends

\$400 = \$0 + \$600 Dividends

Dividends = \$200

2006

Inventory:

Total assets = Total liabilities + Total stockholders' equity

(\$300 + \$300 + Inventory + \$200 + \$600) = (\$300 + \$600) + (\$400 + \$800)

Inventory = \$700

Expenses:

Net income = Sales Expenses

\$400 = \$1,100 Expenses

Expenses = \$700

Dividends:

Ending retained earnings = Beginning retained earnings + Net income Dividends

\$800 = \$400 + \$400 Dividends

Dividends = \$0

2007

Accounts Receivable:

Total assets = Total liab. + Total stockholders' equity

(\$200 + Accts. rec. + \$400 + \$400 + \$700) = (\$500 + \$800) + (\$600 + \$300)

Accounts receivable = \$500

Expenses:

Net income = Sales Expenses

(\$100) = \$700 Expenses

Expenses = \$800

Dividends:

Ending retained earnings = Beginning retained earnings + Net income Dividends

\$300 = \$800 + (\$100) Dividends

Dividends = \$400

4

2008

Accounts Payable:

Total assets = Total liabilities + Total stockholders' equity

(\$500 + \$700 + \$400 + \$400 + \$800) = (Accts. pay. + \$700) + (\$600 + \$600)

Accounts payable = \$900

Net income:

Ending retained earnings = Beginning retained earnings + Net income Dividends

\$600 = \$300 + Net income \$200

Net income = \$500

Sales:

Net income = Sales Expenses

\$500 = Sales \$600

Sales = \$1,100

In order to assess the financial performance of this company, we need to calculate the measures of solvency and earning power. Respective measures are computed as follows:

Measures of Solvency 2005 2006 2007 2008

Current Ratio: 5 4.33 2.20 1.78

Working Capital: \$800 \$1,000 \$600 \$700

Debt/Equity Ratio: .64 .75 1.44 1.33

The only measure of earning power that we can compute for this company is Return on Equity. The other measures, such as EPS and P/E Ratio, cannot be computed since the relevant information is not available.

Measures of Earning Power 2005 2006 2007 2008

Return on Equity: .55 .33 * .42

*No return on stockholder’s equity during 2007 since the company suffered a loss of \$100.

Overall, looking at the measures of solvency and earning power, one can safely conclude that the financial performance and position of the company has deteriorated since its inception in 2005.

The current ratio has continued to decline and working capital has also gone down. While the company has taken more debt, it has been unable to leverage against the interest of the stockholders, since the return on equity has declined considerably. In one year, 2007, the company even suffered a loss.

5

The company paid dividends even during the year of loss, indicating a poorly devised dividend policy.

6

Report this document

For any questions or suggestions please email
cust-service@docsford.com