Chapter 9 Solutions to Problems

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1 Chapter 9 Solutions to Problems 1. a. Cash and cash equivalents are cash in hand and in banks, plus money market securities with maturities of 90 days or less. Accounts receivable are claims on customers for inventory sold to them on credit. Inventory is stock in trade available for sale; products available for sale by the company. Accounts payable is money owed to suppliers for credit purchases. Notes payable is money owed to lenders for short-term loans. b. Total assets $6,370 = Total liabilities $2,760 + Total equity $3,610 c. (1) Net working capital = $3,110 - $1,530 = $1,580 (2) Current ratio = $3,110/$1,530 = 2.03 (3) Debt-equity ratio = $2,760/$3,610 = 0.76 d. Yes, the company appears financially sound liquid and solvent, with borrowing capacity remaining. 2. a. Current ratio = $360,000/$180,000 = 2.0 Current asset turnover = $960,000/$360,000 = 2.67 Return on assets = ($960,000 - $880,000)/$640,000 = $80,000/$640,000 = 0.125, or 12.5% Net working capital = $360,000 - $180,000 = $180,000 b. Luciano Company s working-capital policy is conservative. Its liquidity is higher than average, as evidenced by the current ratio of 2.0 versus 1.5 for the industry. Luciano s current asset turnover is only 2.6 (versus 4.1 for the industry), reflecting its heavy investment in current assets. 3. a. Conservative policy: Assets Liabilities and Equity Current assets $700,000 Current liabilities $350,000 Fixed assets 700,000 Long-term debt 500,000 Equity 550,000 Total assets $1,400,000 Total claims $1,400,000

2 Aggressive policy: Assets Liabilities and Equity Current assets $500,000 Current liabilities $500,000 Fixed assets 700,000 Long-term debt 150,000 Equity 550,000 Total assets $1,200,000 Total claims $1,200,000 b. Conservative policy: Current ratio = $700,000/$350,000 = 2.0 Net working capital = $700,000 - $350,000 = $350,000 Return on assets = $88,000/$1,400,000 = 0.063, or 6.3% Aggressive policy: Current ratio = $500,000/$500,000 = 1.0 Net working capital = $500,000 - $500,000 = $0 Return on assets = $121,000/$1,200,000 = 0.101, or 10.1% c. The conservative policy results in higher liquidity and lower expected profitability, and the aggressive policy results in lower liquidity and higher expected profitability. These relationships demonstrate the trade-off between liquidity and expected profitability. d. The policy Ms. O Doule adopts will depend on her degree of risk aversion and presumably her perceptions of how the stock market will view the policies. 4. a. (1) Net working capital = $4,119,057 - $1,270,135 = $2,848,922 (2) Current ratio = $4,119,057/$1,270,135 = 3.24 (3) Debt-equity ratio = ($1,270,135 + $1,368,115)/$3,300,547 = 0.80 (4) Current asset turnover = $7,079,443/$4,119,057 = 1.72 (5) Return on assets = $1,375,273/$5,938,797 = 0.232, or 23.2%

3 b. Pro forma balance sheet with implementation of Mr. Schneid s idea: Current assets $2,750,942 Current liabilities $1,270,135 Plant & equipment 1,476,841 Long-term liabilities 0 Other assets 342,899 Shareholder equity 3,300,547 Total assets $4,570,682 Total claims $4,570,682 (1) Net working capital = $2,750,942 - $1,270,135 = $1,480,807 (2) Current ratio = $2,750,942/$1,270,135 = 2.17 (3) Debt-equity ratio = $1,270,135/$3,300,547 = 0.38 (4) Current asset turnover = $7,079,443/$2,750,942 = 2.57 (5) Return on assets = $1,480,000/$4,570,682 = 0.324, or 32.4% c. AHP is still highly liquid and solvent, and its ROA increases sharply. 5. a. Apex Company: Current ratio = $700,000/$650,000 = 1.08 Net working capital = $700,000 - $650,000 = $50,000 Current asset turnover = $2,700,000/$700,000 = 3.86 Apogee Company: Current ratio = $160,000/$90,000 = 1.78 Net working capital = $160,000 - $90,000 = $70,000 Current asset turnover = $330,000/$160,000 = 2.06 b. Apex return on assets = $175,000/$1,600,000 = 0.109, or 10.9% Apogee return on assets = $20,000/$280,000 = 0.071, or 7.1% The comparison of Apex and Apogee illustrates the trade-off between liquidity and expected profitability. Apex is less liquid, but it enjoys greater profitability (higher return on assets). 6. a. Net working capital = $830,000 - $300,000 = $530,000 Current ratio = $830,000/$300,000 = 2.77

4 Current asset turnover = $5,000,000/$830,000 = 6.02 b. Yes, because the company has $300,000 current liabilities to finance $200,000 temporary (seasonal) current assets. Oakmont is financing $100,000 of permanent current assets with current liabilities: Permanent needs Fixed assets $1,000,000 Permanent current assets 630,000 Total permanent needs $1,630,000 Less permanent (long-term) sources 1,530,000 Permanent needs financed with short-term sources $ 100,000 c. Oakmont s net working capital ($530,000) and current ratio (2.8) suggest that the financial manager follows a conservative policy. (The current asset turnover is difficult to interpret without an industry average.) In contrast, financing $100,000 of permanent needs with short-term liabilities suggests an aggressive policy. 7. Statement of cash flows: Operating activities: Earnings after taxes $ 46,875 Add depreciation 111,432 Increase in accounts receivable (35,823) Increases in other current assets (15,783) Increase in accounts payable 43,840 Decrease in other current liabilities (12,642) Net cash flow from operating activities $137,899 Investing activities: Increase in fixed assets ($191,877) Decrease in other noncurrent activities 4,063 Net cash flow from investing activities ($187,814) Financing activities: Payment of dividends ($ 16,593) Increase in long-term debt 20,575 Net cash flow from investing activities $ 3,982 Net decrease in cash = $137,899 - $187, ,982 = -$45,933

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