Chapter 2

Solutions

Problem 2 Dover River Company

a.Operating profit (EBIT)......................... $200,000

Interest expense................................. 10,000
Earnings before taxes (EBT).................. 190,000
Taxes.................................................. 38,250
Earnings after taxes (EAT)...................... 151,750
Preferred dividends ........................... 18,750
Available to common shareholders........ $133,000

Common dividends............................ $ 30,000

Increase in retained earnings.................. $ 103,000
EPS = Earnings available to common shareholders/
Number of shares of common stock outstanding
= $133,000/20,000 shares = $6.65 per share
Common Dividends per Share = $30,000/20,000 shares = $1.50 per share

b.Payout Ratio= Common Dividend per share/Earnings per share

=1.50/6.65 per share = 22.6%

c. Increase in retained earnings = $103,000

d. Price/earnings ratio= $41.23/ $6.65 = 6.2 ×

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 Problem 10 Carr Auto Wholesalers
Income Statement
For the Year ended December 31, 20XX

a.
Sales…………………………………………….. $900,000
Cost of goods sold @ 65%................................... 585,000
Gross profit………………………………….. 315,000
Selling and administration expense @ 9%......... 81,000
Amortization expense…………………………... 10,000
Operating profit……………………………… 224,000
Interest expense…………………………………. 8,000
Earnings before taxes………………………… 216,000
Taxes @ 30%........................................................ 64,800
Earnings after taxes…………………………… $151,200

b.
Sales…………………………………………….. $1,000,000
Cost of goods sold @ 60%.................................... 600,000
Gross profit…………………………………... 400,000
Selling and administration expense @ 12%......... 120,000
Amortization expense…………………….…….. 10,000
Operating profit……………………………… 270,000
Interest expense…………………………………. 15,000
Earnings before taxes………………………… 255,000
Taxes @ 30% …………………………………… 76,500
Earnings after taxes…………………………… $ 178,500

Ms. Hood’s idea will increase profitability by $27,300.

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 Problem 12 Dog River Company

a. Operating profit (EBIT)......................... $250,000

Interest expense................................. 21,000
Earnings before taxes (EBT).................. 229,000
Taxes.................................................. 45,550
Earnings after taxes (EAT)...................... 183,450
Preferred dividends ........................... 23,450
Available to common shareholders........ $ 160,000

Common dividends............................ 50,000

Increase in retained earnings.................. $ 110,000

EPS = Earnings available to common shareholders

Number of shares of common stock outstanding
= $160,000/40,000 shares = $4.00 per share

Dividends per Share = $50,000/40,000 shares = $1.25 per share

b. Payout ratio = $1.25/ $4.00 = .3125 = 31.25%

c. Increase in retained earnings = $110,000
d. Price/earnings ratio = $62.00/ $4.00 = 15.5×

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Problem 20 Phelps Labs

a. Total assets...................................... $1,800,000

– Current liabilities......................... 595,000
– Long-term liabilities.................... 630,000
Shareholders' equity........................ 575,000
– Preferred stock.............................. 165,000
Net worth assigned to common....... $ 410,000

Common shares outstanding…............ 20,000

Book value (net worth) per share…..... $20.50

b. Earnings available to common......... $45,000

Shares outstanding........................... 20,000

Earnings per share............................ $2.25

P/E ratio × earnings per share = price

13 × $2.25 = $29.25

c. Market value per share (price) to book value per share

$29.25/$20.50 = 1.43

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 Problem 25
Solitude Corporation
a. Statement of Cash Flows
For the Year Ended December 31, 20XX

Operating activities:
Net income (earnings aftertaxes)............... $ 73,800
Adjustments:
Amortization................................. 11,070
Decrease in accounts receivable.... 7,380
Increase in inventory..................... (22,140)
Increase in accounts payable......... 25,830
Decrease in taxes payable............... (7,380)
Cash provided by operating activities........ 88,560

Investing activities:
Increase in plant and equipment........... (25,830)
Cash used in investing activities................ (25,830)

Financing activities:
Issue of common stock ........................ 22,140
Common stock dividends paid............. (36,900)
Cash used in financing activities………... (14,760)

Net increase in cash (equivalents) during the year.. $ 47,970

Cash, beginning of year………. 29,520
Cash, end of year……………... $ 77,490

b. Major accounts contributing to positive change in cash position are: net income,
payables and common stock issuance. Negative change comes from inventory, plant and
equipment and dividends paid.

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 Problem 26 Waif Corporation
a. Statement of Cash Flows
For the Year Ended December 31, 20XX

Operating activities:
Net income (earnings after taxes)............... $ 91,000
Adjustments:
Amortization................................. 22,000
Increase in accounts receivable.... (12,600)
Decrease in inventory..................... 7,100
Decrease in accounts payable......... (10,000)
Cash provided by operating activities........ 97,500

Investing activities:
Increase in plant and equipment........... (48,000)
Sale of land…………………………… 27,000
Cash used in investing activities................ (21,000)

Financing activities:
Retirement of bonds payable............... (40,000)
Issue of common stock........................ 40,000
Common stock dividends paid……… (39,400)
Cash used in financing activities………... (39,400)

Net increase in cash (equivalents) during the year 37,100

Cash, beginning of year………. 17,400
Cash, end of year……………... $ 54,500

Major accounts contributing to positive change in cash position are: net income, amortization, sale
of land and common stock issuance. Negative change from plant and equipment, bond retirement,
and dividends paid.

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Problem 27
Maris Corporation
Statement of Cash Flows
For the Year Ended December 31, 20XX

Operating activities:
Net income (earnings after taxes)................ $250,000
Adjustments:
Amortization.............................. 230,000
Increase in accounts receivable.. (10,000)
Increase in inventory.................. (30,000)
Decrease in prepaid expenses.... 30,000
Increase in accounts payable..... 250,000
Decrease in accrued expenses... (20,000)
Cash provided by operating activities......... 700,000

Investing activities:
Decrease in investments..................... 10,000
Increase in plant and equipment......... (600,000)
Cash used in investing activities................ (590,000)

Financing activities:
Increase in bonds payable .................. 60,000
Preferred stock dividends paid........... (10,000)
Common stock dividends paid........... (140,000)
Cash used in financing activities……….. (90,000)

Net increase (decrease) in cash 20,000

Cash, at beginning of year 100,000
Cash, end of year $120,000

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Problem 32 Winfield Corporation
Statement of Cash Flows
December 31, 20XX
Operating activities:
Net income (earnings after taxes)............... $ 14,000
Adjustments:
Amortization (buildings)..... $10,500
Gain on sale of investment…….. (5,250)
Loss on sale of equipment........... 1,050
Increase in accounts receivable... (2,450)
Increase in inventory................... (5,250)
Increase in prepaid expenses....... (175)
Decrease in accounts payable..... (1,750)
Increase in accrued expenses...... 1,925
Decrease in interest payable........ (175)
Cash provided by operating activities…...... 12,425

Investing activities:
Proceeds from the sale of stock............ 8,750
Proceeds from the sale of equipment.... 2,450
Purchase of equipment.......................... (15,750)
Cash used in investing activities………….. (4,550)

Financing activities:
Payment towards notes payable............ (6,125)
Increase in bonds payable..................... 5,250
Common stock dividends paid.............. (6,650)
Cash used in financing activities………….. (7,525)

Net increase in cash 350

Cash, beginning of year 1,400
Cash, end of year $ 1,750

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