Name: ______________________________________________________ Period:__________________ Financial Analysis Part One – Accounting Principles and Practices Sections 3.1, 4.3 (to page 119) and 4.1 Goals Describe the three primary financial goals of business Identify the characteristics of effective financial goals Describe the primary responsibility of the financial manager Explain the structure of financial management within an organization Differentiate between accounting and finance Know the basic accounting equation Understand how business transactions affect the accounting equation Explain the accounting cycle Recognize assumptions, principles, and professional practices that guide accountants’ work Vocabulary Creditor Principal Interest Collateral SMART goals Accounting GAAP FASB Creditor Principal Money and capital markets Investments Financial management Equities Accounting equation Assets Liabilities Owner’s Equity Accounts Transactions Entries Source documents Journals Accounting cycle Trial balance Fiscal year Accounting assumptions Single economic entity Going concern Monetary unit Periodic reporting Accounting principles Historical costs Revenue recognition Expense and revenue Matching Full Disclosure Standard Practice and Conservation Professional Practices Due care Information system Information integrity Annual report Sarbanes-Oxley Act 1
Financial AnalysisPart One – Accounting Principles and PracticesSections 3.1, 4.3 (to page 119) and 4.1Goals Describe the three primary financial goals of business Identify the characteristics of effective financial goals Describe the primary responsibility of the financial manager Explain the structure of financial management within an organization Differentiate between accounting and finance Know the basic accounting equation Understand how business transactions affect the accounting equation Explain the accounting cycle Recognize assumptions, principles, and professional practices that guide accountants’ work
VocabularyCreditorPrincipalInterestCollateralSMART goalsAccountingGAAPFASBCreditorPrincipalMoney and capital marketsInvestmentsFinancial managementEquitiesAccounting equationAssetsLiabilitiesOwner’s EquityAccountsTransactionsEntriesSource documents
JournalsAccounting cycleTrial balanceFiscal yearAccounting assumptionsSingle economic entityGoing concernMonetary unitPeriodic reportingAccounting principlesHistorical costsRevenue recognitionExpense and revenue MatchingFull DisclosureStandard Practice and ConservationProfessional PracticesDue careInformation systemInformation integrityAnnual reportSarbanes-Oxley Act
1
Section 3.1 Business Financial GoalsSection 4.3 Financial Management Structure
1) Main Financial NeedsA. Meet financial ____________________________ and pay its _________________.B. Provide a competitive ___________________ for investors.C. Finance future _______________ and _______________________ to remain competitive.
2) Characteristics of Effective GoalsA. Specific: B. Measurable: C. Attainable/Realistic: D. Results-Oriented: E. Time Bound:
3) Main Goal of Financial Management: maximize ___________________________ wealth.4) Financial Management Decisions
A. Asset Planning: B. Asset Financing: C. Asset Management:
Section 4.1 Financial and AccountingFinance Accounting
2
The Accounting Equation
3
= +
= +
-
5) Accounting AssumptionsA. Single Economic Entity B. Going Concern C. Monetary Unit D. Periodic Reporting
6) Accounting PrinciplesA. Historical Costs B. Revenue Recognition C. (Expense & Revenue) Matching D. Full Disclosure E. Standard Practice F. Conservatism
7) Professional PracticeA. Competence B. Due Care & Sufficient Data C. Independence & Integrity
4
0. Collect and analyze source documents
Section 3.1 Homework1) Textbook page 71 – Questions 1-52) How does the sale of products and services by the business provide money to finance operations?3) Why are the shareholders of closely-held corporations more likely to accept a lower rate of return
than shareholders in large corporations?4) What is the difference between growth and improvement?5) Is it possible for a business to grow and not improve or to improve but not grow? Explain.6) What three options do businesses have to finance growth?7) What compensations do businesses with poor finances often need to make in order to obtain
financing?8) Reword the following goal so that it meets the SMART criteria: To provide an adequate investor
return.9) Under what situations might a company want to focus on meeting current financial obligations?10)What major financial decision must a company focused on growth make?11)What can a company do to attract more investors?12)Textbook page 96 – Questions 16-19Section 4.3 Homework13)Textbook page 123 – Questions 1-4, 814)Why do companies make investments?15)How do financial managers determine which assets to purchase?16)Why are mergers and acquisitions considered part of asset planning?17)How is a trade credit different from an operating loan?18)What types of activities are involved in managing fixed assets?19)What might happen if a company has too many fixed assets and not enough liquid assets? too
many liquid assets and not enough fixed assets?20)Textbook page 136 – Question 18Section 4.1 Homework21)Textbook page 109 – Questions 1-522)What are the three interrelated areas of finance?23)How are GAAP and the FASB related to the accounting principle of standard practices?24)What two items make up the equity of a business?25)How do accounts help financial managers make decisions?26)What form is used to record transactions?27)What is a fiscal year?28)What is the purpose of a trial balance?29)Why do accountants have to make adjusting entries?30)What is the purpose of closing entries?31)Textbook page 136 – Questions 15-17, 2032) Identify each account as an Asset (A), Liability (L), Owner’s Equity (OE), Revenue (R) or Expense (E).
A. Accounts PayableB. Accounts ReceivableC. Administrative ExpenseD. BuildingsE. CashF. Common StockG. EquipmentH. General ExpenseI. Interest ExpenseJ. InventoriesK. Land
Section 4.2 Independent Section33)Read the section and answer the checkpoint questions on pages 111, 114, and 116 (questions 1-5
only).34)Read page 115. How did the Sarbanes-Oxley Act restore investor confidence?
Financial AnalysisPart Two – Financial Statement PreparationSections 3.2 and 4.3 (pages 119-122)Goals State the purpose of the income statement, statement of retained earnings, balance sheet and
cash flow statement Be able to prepare an income statement, statement of retained earnings, balance sheet and cash
flow statement
VocabularyFinancial statementsUnderstandableReliableComparableBalance sheetCurrent assetsReceivablesLong-term assetsDepreciationCurrent liabilitiesPayablesLong-term liabilitiesRetained EarningsPaid-in capital in excess of parWorking capitalIncome statementRevenueCost of RevenueGross Profit/IncomeOperating ExpensesNet Profit/IncomeCash flow statementCash receiptsCash paymentsSolvencyCash from operating activitiesCash from investing activitiesCash from financing activities
Section 3.2 Accounting StatementsA. Income Statement Preparation
Purpose of the Statement:
Use the form below to prepare an income statement for Shutterbug Cameras for the year ended June 30. Shutterbug pays an average tax rate of 30%. During the year Shutterbug Cameras recorded sales revenue of $127,151. Shutterbug paid for the following:
Use the form below to prepare statement of retained earnings for Shutterbug Cameras for the year ended June 30. Shutterbug started the year with retained earnings of $14,364. The company declared a dividend for all shareholders of $15,000. Preferred shareholders were entitled to $5,000 of the dividend.
C. Balance Sheet Preparation
Purpose of Statement:
Use the form below to prepare a balance sheet for Shutterbug Cameras for the June 30. Shutterbug provided the following information:
Accounts Payable $ 14,481 Accounts Receivable $ 5,418 Cash in Bank $ 137,721.20 Common Stock $ 60,000 Inventory $ 82,763 Land and Building $ 6,303 Lease $ 64,410 Paid-In Capital in Excess of Par $ 75,000 Preferred Stock $ 25,000 Sales Tax Payable $ 891 Store Equipment $ 26,769
D. Cash Flow Statement Preparation
Purpose of Statement:
Use the form below to prepare a cash flow statement for Shutterbug Cameras for the year ended June 30. Shutterbug had the following additional payments and receipts:
Bonds Issued/Paid $ ( 9,106 )Common Stock Issued/Repurchased $ 10,000 Payments from Accounts Receivable $ 8,751 Payments of Accounts Payable $ (17,139)Purchase/Sale of Assets $ ( 1,067)Purchase/Sale of Marketable Securities $ 4,231
Section 3.2 Homework1) How is profit or loss calculated on an income statement?2) What important financial information is not reflected in either the balance sheet or the income
statement?3) Which financial statement proved the accounting equation?4) Which financial statement gives the best indication of a company’s ability to compete in the future?5) Which number of the financial statements represents the amount of income available to
stockholders?6) What items can cause a change in retained earnings?7) Textbook page 79 – Questions 1, 2, 3, 4, 5, 88) Identify the statement(s) on which each account is found:
9) Use the information to prepare an income statement, statement of retained earnings, balance sheet and cash flow statement for Kramer Corporation for the year ended December 31. All numbers are in thousands. Accounts Payable..............................$80.0Accounts Receivable........................$200.0Accumulated Depreciation...............$600.0Cash..................................................$40.0Common Stock Dividends..................$39.5Common Stock................................$100.0Cost of Goods Sold........................$1,500.0Depreciation Expense........................$50.0Fixed Liabilities..................................$90.0Interest Expense................................$20.0Inventory.........................................$190.5Marketable Securities........................$10.0Notes Payable..................................$100.0Other Assets......................................$70.0Other Current Liabilities.....................$30.0
Paid-In Capital in excess of par.............$250.0
Plant & Equipment................................$1,100.0Preferred Stock Dividends..........................$10.5Preferred Stock, $100 par, 500 shares.......$50.0Retained Earnings, Jan. 1.........................$250.0Sales.....................................................$2,000.0Selling and Admin. Expense.....................$220.0Taxes.........................................................$99.5Additional Information for Cash Flow StatementPayment from Accounts Receivable...........$10.5Payments of Accounts Payable.................($50.0)Sale of Assets...............................................$9.5Purchase of Marketable Securities..........($200.0)Common Stock Issued................................$15.0Bonds Paid...........................................($1,000.0)
10)Use the information given to prepare an income statement, statement of retained earnings, balance sheet and cash flow statement for Argyle Textiles for the year ended December 31. All numbers are in millions.Tax Expense......................................$18.0Sales................................................$750.0Salary Expense..................................$15.0Retained Earnings...........................$130.0Rent Expense.....................................$40.0Preferred Stock....................................$5.0Preferred Dividends.............................$4.0Notes Payable....................................$50.0Marketable Securities..........................$1.2Long-Term Bonds.............................$152.2Land and Buildings..........................$345.0Inventory.........................................$135.0Interest Expense................................$20.0Depreciation Expense........................$30.0Cost of Goods Sold...........................$600.0
Common Stock...........................................$10.0Common Dividends....................................$10.0Cash in Bank................................................$9.0Accumulated Depreciation.......................$155.0Accounts Payable.......................................$15.0Accounts Receivable..................................$90.0Paid-In Capital in Excess of Par..................$50.0Additional Information for Cash Flow StatementPayment from Accounts Receivable.............$5.5Payments of Accounts Payable...................($5.0)Sale of Assets...............................................$9.5Sale of Marketable Securities.......................$2.0Common Stock Repurchased......................($1.0)Bonds Issued................................................$1.0
11)Use the information given to prepare an income statement, statement of retained earnings, balance sheet and cash flow statement for Computron Industries for the year ended December 31. Cash..............................................$52,000Accounts Receivable....................$402,000Inventories...................................$836,000
Plant and Equipment.........................$527,000Accumulated Depreciation................$166,200Accounts Payable..............................$315,200
Notes Payable..............................$225,000Bonds Payable.............................$424,612Common Stock............................$100,000Paid-in Capital in Excess of Par....$300,000Preferred Stock..............................$60,000Retained Earnings........................$279,768Sales.........................................$3,850,000
Cost of Goods Sold.........................$3,250,000Administrative Expenses...................$430,300Selling Expenses.................................$20,000Interest Expense.................................$76,000
Tax......................................................$29,480Common Stock Dividends....................$86,000Preferred Stock Dividends...................$12,000Additional Information for Cash Flow StatementBonds Issued.......................................$10,000Payment from Accounts Receivable. .$114,000Payments of Accounts Payable..........($95,000)Purchase of Marketable Securities.....($20,000)Sale of Assets........................................$9,500
12)Textbook page 96 & 97 – Question 20, 23, 26-28.13)Which accounts should you add together to get total common stockholders’ equity?
Income StatementSales
- Cost of Goods SoldGross Profit
- Operating Expenses Operating Profit
- Interest Expense Income before taxes
- Tax Expense Net Income
Balance SheetAssets
Current Assets+ Fixed Assets
Total AssetsLiabilities
Current Liabilities+ Long-Term Liabilities
Total LiabilitiesStockholders’ Equity+ Preferred Stock+ Common Stock+ Paid-In Capital in Excess of Par+ Retained Earnings
Total Stockholders’ Equity Total Liabilities and S/E
Cash Flow StatementCash Flow from Operations Net Income+ Payments from A/R- Payments to A/P
Cash Flow from Operations
Cash Flow from Investing Purchase/Sale of Assets+/- Purchase Sale of Marketable Sec. Cash Flow from Investing
Cash Flow from Financing Common Stock Issue/Repurchase- Stock Dividends+/- Bonds Issued/Paid Cash Flow from Financing
Net Cash Flow
Statement of Retained EarningsBeginning Retained Earnings
+ Net Income- Dividend Payments
Ending Retained Earnings
Financial AnalysisPart Three – Ratio AnalysisSection 4.4Goals Recognize important ratios used to analyze the financial condition of a business Identify the five ratio categories and the purpose of each category Use current financial statements to perform a complete ratio analysis for a company Analyze ratios using cross-sectional and time-series analysis Define leverage and explain how it can be used to improve investor return
Ratio Formula What It MeansLiquidity - ability to satisfy short-term debt
Current Ratio Current AssetsCurrent Liabilities
Value of liquid assets available to cover short-term debt
Quick Ratio Current Assets – InventoryCurrent Liabilities
Same as current except inventory is not included in liquid assets
Activity – speed with which various accounts are converted into sales or cash
Inventory Turnover SalesInventory
How many times during the year the company turns over inventory (reorders)
Average Age of Inventory
360Inventory Turnover
How many days goods stay in stock before being sold
Accounts Receivable Turnover
Total SalesA/R
How quickly customer accounts are paid
Average Collection Period
Accounts ReceivableSales ÷ 360
Number of days it takes company to collect from customers
Total Asset Turnover SalesTotal Assets
How efficiently the company is using its assets to generate sales
Debt Ratios – degree of indebtedness and the ability of the firm to pay debts
Debt Ratio Total LiabilitiesTotal Assets
Percentage of firms assets owned by others (creditors).
Times Interest Earned
Operating Income Interest Expense
How many times a year the company makes enough income to pay interest expenses
Profitability – ability to earn income
Gross Profit Margin Gross ProfitSales
Percentage of sales dollar left after goods are purchased
Operating Profit Margin
Operating ProfitSales
Percentage of sales dollar left after goods are purchased & operating expenses paid
Net Profit Margin Net IncomeSales
Percentage of sales dollar left after all expenses are deducted
Return on Assets Net IncomeTotal Assets
How much money the firm earned from each dollar of asset investment
Return on Equity Net IncomeCS Equity
How much money the firm earned from each dollar of shareholder investment
Market Ratios – relate a firm’s current price in the market to the accounting values
Earnings per Share Net Income# CS shares outstanding
Number of dollars earned on behalf of each shareholder.
Price/Earnings (P/E) Market PriceEarnings per Share
How much money are investors willing to pay for each dollar of a firm’s earnings
Market to Book Market PriceCS Equity ÷ Issued Shares
How much more investors are willing to pay for stock than the amount listed in the balance sheet
Section 4.4 Homework1) What is the purpose of performing a ratio analysis?2) What three activities are required when performing a ratio analysis?3) What are the five categories of financial ratios? What does each category tell you about the
business?4) Under what circumstances would the current ratio be the preferred measure of overall firm
liquidity? Under what circumstances would the quick ratio be preferred?5) A company has a total asset turnover of 0.85. What does this number mean? Who would be most
interested in this number: the stockholders or the managers? Why?6) What ratio measured the degree of indebtedness? What ratio assesses the firm’s ability to pay
debts?7) Why is it important to calculate all three profit margins (gross, operating and net)?8) What would explain a firm’s having a high gross profit margin and a low net profit margin?9) Which measure of profitability is probably of greatest interest to the investing public? Why?10)Why are market-to-book ratios generally greater than 1.0?11)What should you consider when selecting which comparative information to use?12)What is a benchmark company and how is it used when analyzing financial ratios?13)Textbook page 133 – Questions 1, 2, 3, 4, 514)Textbook page 136 – Questions 19, 2215) Beacon Company’s total current assets, total current liabilities, and inventory for the past 4 years follow:
a. Calculate the firm’s current and quick ratios for each year. b. Comment on the firm’s liquidity over the 1998-2001 period.c. If you were told that Beacon Company’s inventory turnover for 1998-2001 and the industry
averages were as follows, would this support or conflict with your evaluation in part b? Why?
16)
The new owners of Celestial Natural Foods have hired you to help them diagnose and cure problems that the company has had in maintaining adequate liquidity. First, you perform a liquidity analysis. You then do an analysis of the company’s short-term activity ratios. Your calculations and industry norms are listed.
Celestial Industry normCurrent ratio 4.5 4.0Quick ratio 2.0 3.1Inventory turnover 6.0 10.4Average collection period 73 days 52 days
a. What recommendations about the amount and the handling of inventory could you make to the new owners?
b. What recommendations about amount and handling of accounts receivable could you make to the owners?
17)Gemtel, Inc., ended 2001 with net profit before taxes of $218,000. The company is subject to a 40% tax rate and must pay $32,000 in preferred stock dividends before distributing any earnings on the 85,000 shares of common stock currently outstanding.
a. Calculate Gemtel’s 2001 earnings per share (EPS).b. If the firm paid common stock dividends of $0.80 per share, how many dollars would go to
retained earnings?
Inventory turnover 1998 1999 2000 2001Beacon Company 6.3 6.8 7.0 6.4Industry average 10.6 11.2 10.8 11.0
18)Complete the 2001 balance sheet for Orphan Industries using the information that follows it.Balance Sheet
Orphan IndustriesDecember 31, 2001
Cash $ 30,000 Accounts payable $ 120,000Marketable securities 25,000 Notes payable ________Accounts receivable ________ Accruals 20,000Inventories 225,000 Total current liabilities ________ Total current assets ________ Long-term debt ________Net fixed assets ________ Stockholders’ equity 600,000 Total assets ________ Total liabilities & stockholders’ equity ________The following financial data for 2001 is also available:(1) Sales totaled $1,800,000.(2) There are 360 days in the year.(3) The average collection period was 40 days.
(4) The current ratio was 1.60.(5) The total asset turnover ratio was 1.20.(6) The debt ratio was 60%.
19) Arnold Roberts recently inherited a stock portfolio from his uncle who was a very wise investor. To learn more about the companies that he is now invested in, Arnold performs a ratio analysis on each one and decides to compare them to each other. Some of his ratios are listed below.
AtlanticElectric Utility
MightyBurger
Think Software
RauchMotors
Current ratio 1.10 1.3 6.8 4.5Quick ratio 0.90 0.82 5.2 3.7Debt ratio 0.68 0.46 0 0.35Net profit margin
6.2% 14.3% 28.5% 8.4%
Arnold finds the wide differences in these ratios confusing. Help him out. a. What problems might Arnold encounter in comparing the ratios of these companies to one
another? b. Why might the current and quick ratios for the electric utility and the fast-food stock be so
much lower than the same ratios for the other companies?c. Why might it be all right for the electric utility to carry a large amount of debt, but the same is
not true for the software company?d. Why wouldn’t investors invest all of their money in software companies instead of less
profitable companies?20) Winner Paper and Oregon Forest are rivals in the manufacture of craft papers. Some financial statement
values for each company are listed below. Winner Paper Oregon Forest
Total assetsTotal common equityTotal debtAnnual interestTotal salesEBITNet income
a. Calculate the (1) debt ratio and (2) times interest earned ratio for the two companies. Discuss their financial risk and ability to cover the costs in relation to each other.
b. Calculate the (1) operating profit margin, (2) net profit margin, (3) return on total assets, and (4) return on common equity for the two companies. Discuss their profitability relative to each other.
c. In what way has the larger debt of Oregon Forest made it more profitable than Winner Paper? What are the risks that Oregon’s investors undertake when they choose to purchase its stock instead of Winner’s?
21) Rock Enterprises has requested a $4,000,000 loan. Zenia Bank is evaluating Rock to assess its financial position. On the basis of the debt ratios for Rock, along with the industry averages and Rock’s recent financial statements, evaluate and recommend appropriate action on the loan request.
Income StatementRock Enterprises
for the year ended December 31, 2001Sales revenueLess: Cost of goods soldGross profitsLess: Operating expensesOperating profitsLess: Interest expenseNet profits before taxesLess: Taxes (rate = 40%)Net profits after taxesLess: Preferred stock dividendsEarnings available for common stockholders
Liabilities & Stockholders’ EquityCurrent liabilities Accounts payable Notes payable Accruals Total current liabilitiesLong-term debtb
Stockholders’ equity Preferred stock ($4 dividend) Common stock Paid-in capital in excess of par Retained earnings Total stockholders’ equityTotal liabilities & stock. equity
a The firm has a lease requiring annual payments of $200,000. Three years of the lease have yet to run. bRequired annual principal payments are $800,000.
Industry AveragesDebt ratio 0.51Times interest earned ratio 7.30
22)Solana Printing, Inc., had sales totaling $40,000,000 in fiscal year 2001. Some ratios for the company are listed below. Use this information to calculate the dollar values of the following accounts:
A. Gross profitsB. Cost of goods soldC. Operating profitsD. Operating expense
Solana Printing, Inc.Gross profit marginOperating profit marginNet profit marginReturn on total assetsReturn on common equityTotal asset turnoverAverage collection period
80% 35% 8% 16% 20% 2 62.2 days
E. Net IncomeF. Total assetsG. Total common stock equityH. Accounts receivable
23)Use the financial statements for Mark Manufacturing Company along with the industry average to (a.) prepare a complete ratio analysis of the firm’s 2001 operations. (b.) Summarize your findings.
Mark Manufacturing CompanyIncome Statement
Year Ended December 31, 2001Sales Revenue $600,000Cost of Goods Sold 460,000Gross Profit $140,000Operating Expenses 60,000Operating Profits $80,000Interest Expense 10,000Net Income before taxes $70,000Tax Expense 27,100Net Income $42,900Earnings per Share (EPS) $2.15
Mark Manufacturing Company
Balance SheetDecember 31, 2001
Assets Liabilities and Stockholders’ EquityCash $15,000 Accounts Payable $57,000Marketable Securities 7,200 Notes Payable 13,000Accounts Receivable 34,100 Accruals 5,000Inventories 82,000 Total Current Liabilities $75,000 Total Current Assets $138,300 Long-term Debt $150,000Net Fixed Assets 270,000 Stockholders’ EquityTotal Assets $408,300 Common Stock (20,000 shares
Industry AveragesCurrent ratio 2.35 Times interest earned ratio 12.3Quick ratio 0.87 Gross profit margin 0.202Inventory turnover 4.55 Operating profit margin 0.135Average collection period 35.3 days Net profit margin 0.091Total asset turnover 1.09 Return on total assets (ROA) 0.099Debt ratio 0.30 Return on common equity
(ROE)0.167
Earnings per Share (EPS) $3.10
24)Use the financial statements for Jessica Industries to complete the chart. Then analyze Jessica Industries’ financial condition as it relates to (1) liquidity, (2) activity, (3) debt, (4) profitability, and (5) market. Summarize the company’s overall financial condition.
Ratio Industry average
Actual 2000 Actual 2001
Current ratioQuick ratioAverage collection periodDebt ratioTimes interest earned ratioGross profit marginNet profit marginReturn on total assetsReturn on common equityMarket/book ratio
Jessica IndustriesIncome Statement for year ended December 31, 2001
Sales revenueLess: Cost of goods soldGross profitsLess: Operating expensesOperating profitsLess: Interest expenseNet profits before taxesLess: T axesNet profits after taxes
Jessica IndustriesBalance Sheet for December 31, 2001
Assets Liabilities and Stockholders’ EquityCash $500 Accounts Payable $22,000Marketable Securities 1,000 Notes Payable 47,000Accounts Receivable 25,000 Total Current Liabilities $69,000Inventories 45,000 Long-term Debt $22,950 Total Current Assets $72,000 Common Stock (3,000 shares issued)* $31,500Net Fixed Assets 78,000 Retained Earnings 26,550Total Assets $150,000 Total Liabilities & Stockholders’ Equity $150,000
The firm’s stock closed 2001 at a price of $25 per share.
Integrative Problems25)Charter Air, Inc., reported net income of $1,365,000 for the year ended December 31, 2001. Show
the effect of these funds on the firm’s balance sheet in each of the scenarios following the balance sheet.
Charter Air, Inc.Balance Sheet
December 31, 2000Cash $ 120,000 Accounts payable $ 70,000Marketable securities 35,000 Short-term notes 55,000Accounts receivable 45,000 Current liabilities $ 125,000Inventories 130,000 Long-term debt $2,700,000 Current assets $ 330,000 Total liabilities $2,825,000Equipment $2,970,000 Common Stock $ 500,000Buildings 1,600,000 Retained earnings 1,575,000 Fixed assets $4,570,000 Stockholders’ equity $2,075,000Total assets $4,900,000 Total liabilities and equity $4,900,000
a. Charter paid no dividends during the year and invested the funds in marketable securities.b. Charter paid dividends totaling $500,000 and used the balance of net income to retire long-term debt.c. Charter paid dividends totaling $500,000 and invested the balance of net income in building a new hangar.d. Charter paid out all $1,365,000 as dividends to its stockholders.
26) Kleck Corporation has one issue of preferred stock and one issue of common stock outstanding. Given Kleck’s stockholders’ equity account that follows, determine the original price per share at which the firm sold its single issue of common stock.
Paid in capital in excess of par on common stock 2,625,000Retained earnings 900,000Total Stockholders’ equity $3,875,000
27)Listed are the equity sections of balance sheets for years 2000 and 2001 as reported by Resort World, Inc. The overall value of stockholders’ equity has risen from $2,000,000 to $7,500,000. Use the statements to discover how and why this happened.
Resort World Inc. 2000 2001
Stockholders’ equityCommon stock ($1.00 par) Authorized – 5,000,000 shares Outstanding – 1,500,000 shares 2001 - 500,000 shares 2000 $ 500,000 $1,500,000Paid-in capital in excess of par 500,000 4,500,000Retained earnings 1,000,000 1,500,000Total stockholders’ equity $2,000,000 $7,500,000
The company paid total dividends of $200,000 during fiscal 2001.a. What was Resort World’s net income for fiscal 2001?b. How many new shares did the corporation issue and sell during the year?c. At what average price per share did the stock sold during 2001 sell?d. At what price per share did Resort World’s original 500,000 shares sell?
Financial AnalysisPart Four – Time Value of MoneySection 3.4Goals
Discuss the role of time value in finance Know how to calculate time value problems using a financial calculator Understand the concepts of future value and present value Calculate future and present values for a single amount Calculate the effective annual rate Understand the concept of an annuity and perpetuity Calculate future and present values for annuities
VocabularyTime value of moneySimple interestCompound interestFuture valueCompoundingPresent valueDiscountingEffective Annual RateAnnuityAnnuity duePerpetuityRule of 72
Section 3.4 Interest Rates and Time Value of Money
1) Role of Time Value in Finance
a) Most financial decisions involve ____________ and _______________ that are spread out over ___________.
b) Time value of money allows _________________ of cash flows from ______________________ periods.
2) Types of Interest
a) Simple Interest -
b) Compound Interest -
Computational Aid 1
0 1 2 3 4 5
End of Year
N:
I%:
PV:
PMT:
FV:
P/Y:
C/Y:
-$10,000 $3,000 5,000 $4,000 $3,000 $2,000
To Access the Finance Functions:
APPS…FINANCE…TVM
To Solve a Problem:
The cursor should be on the item for which you are solving
Press ALPHA…SOLVE
Sample Problems – Lump SumsCase
Lump Sum
Interest Rate Years Future Value Present Value
A $200 5% 20
B 4,500 8 7
C 10,000 9 10
D 25,000 10 12
E 37,000 11 5
F 40,000 12 9
3) More on Compound Interest
a) Compounding more frequently than once a year will result in a ______________ effective interest rate because you are earning interest on interest more frequently.
b) As a result, the ___________________ interest rate is greater than the ____________________ interest rate.
c) The effective rate of interest _________________ the more frequently interest is compounded.
a) Can be a cash ______________________ or cash ________________________
b) Types
(1) Ordinary – payments received/due at the _________________ of the period.
(2) Due – payments received/due at the _____________________________ of the period.
(3) Perpetuity – annuity with a cash flow that continues _________________________.
Sample Problems - AnnuitiesCase
Type Payment
Interest Rate Years Future Value Present Value
A Ordinary
$12,000 7% 3
B Ordinary 55,000 12 15
C Ordinary 700 20 9
D Ordinary
140,000 5 7
E Due 22,500 10 5
F Ordinary
100,000 10 N/A
G Due 3,000 8 4
Perpetuity
PV = Annuity / i
Section 3.4 HomeworkLump Sum Problems1. What is the difference between simple interest and compound interest?2. What is the difference between future value and present value? 3. What effect would a decrease in the interest rate have on the future value of a deposit? What effect
would an increase in the holding period have on future value?4. Larry Doby invests $50,000 in a mint condition 1952 Mickey Mantle Topps baseball card. He
expects the card to increase in value 8% per year for the next five years. How much will his card be worth after five years?
5. At a growth rate of 9 percent annually, how long will it take for a sum to double? To triple? Round the answer to the nearest whole number of years. Bonus: How does the Rule of 72 apply to this question?
6. You have $1,500 to invest today at 7% interest. a. Find how much you will have accumulated in the account at the end of (1) three years; (2)
six years; (3) nine years.
b. Use your findings in part a to calculate the amount of interest earned in (1) the first three years (years 1 to 3); (2) the second three years (years 4 to 6); and (3) the third three years (years 7 to 9).
c. Explain why the amount of interest earned increases in each succeeding 3-year period.7. As part of your financial planning, you wish to purchase a new car exactly 5 years from today. The
car you wish to purchase costs $14,000 today, and your research indicates that its price will increase by 2% to 4% per year over the next five years.
a. Estimate the price of the car at the end of 5 years if inflation is (1) 2% per year; (2) 4% per year.
b. How much more expensive will the car be if the rate of inflation is 4% rather than 2%?8. You can deposit $10,000 into an account paying 9% interest either today or exactly 10 years from
today. How much better off will you be at the end of 40 years if you decide to make the initial deposit today rather than ten years from today?
9. What effect does increasing the required return have on the present value of a future amount? Why?
10. How are present value and future value calculations related?11. You owe a creditor $40,000 in seven years. If you decide to payoff the loan today, what is the most
you should pay the creditor to payoff the loan in full if the prevailing interest rate is 9%?12. You need $28,974 at the end of 10 years. Your only investment option is an 8% long-term CD
compounded annually. What single payment could be made at the beginning of the first year to achieve this objective?
Compounding Problems13. What effect does compounding interest more frequently than annually have on future value? 14. What effect does compounding interest more frequently than annually have on effective annual
rate?15. Juan Garza invested $20,000 ten years ago at 12% interest compounded quarterly. How much has
he accumulated in the investment?16. The First City Bank pays 7% interest compounded annually on deposits. The Second City Bank pays
6.5% interest compounded quarterly. Based on their effective interest rates, in which bank would you prefer to deposit your money?
Annuity Problems17. You have decided to heed the sage advice of your finance teacher and put aside $2,000 a year
beginning with your 25th birthday and continuing for 10 years. Your best friend, on the other hand, decides to wait until s/he is 35 before making the $2,000 annual payments. Provide the information requested about the investments assuming a 10% compounding rate.
a. How much money will you deposit over the 10-year period? b. How much money will your best friend deposit over the 30-year period?
c. How much money will you have at your age 65? d. How much money will your best friend have at age 65?
18. You have won the lottery and are trying to decide whether to take the lump sum payment or the
annuity. The annuity has a value of $9 million dollars to be paid in annual payments over the next
20 years. If the annuity earns 5% interest, what will be the amount of the lump sum payment? What factors should you consider when deciding between the annuity and lump sum payment?
19. Your favorite aunt has left you some money in her will. The will specifies that you will receive: $1,000 one year from her death; $2,000 two years from her death; and $3,000 three years from her death. How much is your aunt’s gift worth today? Use 8% interest.
20. You would like to give back to the Council Rock community by funding an endowment for the Parks & Recreation Department. You would like the department to have $15,000 available every year for community programs. How much money would you need to invest today to fund this endowment at 7% interest?
21. Sue wants to buy a car that costs $12,000. She has arranged to borrow the total purchase price of the car from her credit union at a simple interest rate equal to 12 percent. The loan requires quarterly payments for a period of three years. If the first payment is due in three months (one quarter) after purchasing the car, what will be the amount of Sue’s quarterly payments on the loan?
Reinforcement Problems22. You are planning to retire in twenty years. You'll live ten years after retirement. You want to be able
to draw out of your savings at the rate of $10,000 per year. How much would you have to pay in equal annual deposits until retirement to meet your objectives? Assume interest remains at 9%.
23. You can deposit $4000 per year into an account that pays 12% interest. If you deposit such amounts for 15 years and start drawing money out of the account in equal annual installments, how much could you draw out each year for 20 years?
24. What is the value of a $100 perpetuity if interest is 7%? 25. You deposit $13,000 at the beginning of every year for 10 years. If interest is being paid at 8%, how
much will you have in 10 years? 26. You are getting payments of $8000 at the beginning of every year and they are to last another five
years. At 6%, what is the value of this annuity? 27. How much would you have to deposit today to have $10,000 in five years at 6% interest
compounded semiannually? 28. If you get payments of $15,000 per year for the next ten years and interest is 4%, how much would
that stream of income be worth in present value terms? 29. Your company must make equal annual beginning of year payments to have enough money to
retire an $800,000 bond that matures in 15 years. Assuming you can earn 4% interest, how much must the payments be?
30. If you deposit $45,000 into an account earning 4% interest compounded quarterly, how much would you have in 5 years?
31. How much would you pay for an investment that will be worth $16,000 in three years? Assume interest is 5%.
32. You have $100,000 to invest at 4% interest. If you wish to withdraw equal annual payments for 4 years, how much could you withdraw each year and leave $0 in the investment account?
33. You are considering the purchase of two different insurance annuities. Annuity A will pay you $16,000 at the beginning of each year for 8 years. Annuity B will pay you $12,000 at the end of each year for 12 years. Assuming your money is worth 7%, and each costs you $75,000 today, which would you prefer?
34. If your company borrows $300,000 at 8% interest and agrees to repay the loan in 10 equal semiannual payments to include principal plus interest, how much would those payments be?
35. You deposit $17,000 each year for 10 years at 7%. Then you earn 9% after that. If you leave the money invested for another 5 years how much will you have in the 15th year?
