Demonstration Problem

Demonstration Problem
Accounting What the Numbers Mean 6e Demonstration Problem Chapter 11 – Problem 9 Ratio Analysis – Comprehensive Problem

Condensed Balance Sheets
Problem Definition Presented below are summarized data from the balance sheet and income statement of Wiper, Inc.: Wiper, Inc. Condensed Balance Sheets December 31, 2004, 2003, and 2002 Current assets $ $ $ 736 Other assets , , ,719 $3, $2, $2,455 Current liabilities $ $ $ 710 Other liabilities , Owners’ equity , , $3, $2, $2,455

Problem Definition Income statement data: 2004 2003
Wiper, Inc. Selected Income Statement Data and Other Data For the Years Ended December 31, 2004 and 2003 (in millions) Income statement data: Sales $3, $2,913 Operating income Interest expense Net income Other data: Average number of common shares outstanding Total dividends paid $ $

Problem Definition Calculate return on investment, based on net income and average total assets, for 2004 and Show both margin and turnover in your calculation. Calculate return on equity for 2004 and 2003. Calculate working capital and the current ratio for each of the past three years. Calculate earnings per share for 2004 and 2003. If Wiper’s stock had a price/earnings ratio of 13 at the end of 2004, what was the market price of the stock? Calculate the cash dividend per share for 2004 and the dividend yield based on the market price calculated in part e.

Problem Definition Calculate the dividend payout ratio for 2004.
Assume that accounts receivable at December 31, 2004, totaled $309 million. Calculate the number of days’ sales in receivables at that date. Calculate Wiper’s debt ratio and debt/equity ratio at December 31, 2004 and 2003. Calculate the times interest earned factor for 2004 and 2003. Review the results of these calculations, evaluate the profitability and liquidity of this company, and state your opinion about its suitability as an investment for a young, single professional with funds to invest in common stock.

Problem Definition a. ROI = Margin x Turnover
Net income Net income Sales Average total assets Sales Average total assets

Net income Net income Sales Average total assets Sales Average total assets 2004 ROI =

Net income Net income Sales Average total assets Sales Average total assets 2004 ROI = ($192 / $3,050)

Net income Net income Sales Average total assets Sales Average total assets 2004 ROI = ($192 / $3,050) * [$3,050 / (($2,811 + $3,090) / 2)]

Net income Net income Sales Average total assets Sales Average total assets 2004 ROI = ($192 / $3,050) * [$3,050 / (($2,811 + $3,090) / 2)] = 6.3% margin

Net income Net income Sales Average total assets Sales Average total assets 2004 ROI = ($192 / $3,050) * [$3,050 / (($2,811 + $3,090) / 2)] = 6.3% margin * turnover

Net income Net income Sales Average total assets Sales Average total assets 2004 ROI = ($192 / $3,050) * [$3,050 / (($2,811 + $3,090) / 2)] = 6.3% margin * turnover = 6.5% ROI

Net income Net income Sales Average total assets Sales Average total assets 2004 ROI = ($192 / $3,050) * [$3,050 / (($2,811 + $3,090) / 2)] = 6.3% margin * turnover = 6.5% ROI 2003 ROI =

Net income Net income Sales Average total assets Sales Average total assets 2004 ROI = ($192 / $3,050) * [$3,050 / (($2,811 + $3,090) / 2)] = 6.3% margin * turnover = 6.5% ROI 2003 ROI = ($187 / $2,913)

Net income Net income Sales Average total assets Sales Average total assets 2004 ROI = ($192 / $3,050) * [$3,050 / (($2,811 + $3,090) / 2)] = 6.3% margin * turnover = 6.5% ROI 2003 ROI = ($187 / $2,913) * [$2,913 / (($2,455 + $2,811) / 2)]

Net income Net income Sales Average total assets Sales Average total assets 2004 ROI = ($192 / $3,050) * [$3,050 / (($2,811 + $3,090) / 2)] = 6.3% margin * turnover = 6.5% ROI 2003 ROI = ($187 / $2,913) * [$2,913 / (($2,455 + $2,811) / 2)] = 6.3% margin

Net income Net income Sales Average total assets Sales Average total assets 2004 ROI = ($192 / $3,050) * [$3,050 / (($2,811 + $3,090) / 2)] = 6.3% margin * turnover = 6.5% ROI 2003 ROI = ($187 / $2,913) * [$2,913 / (($2,455 + $2,811) / 2)]

Problem Definition b. ROE = Net income / Average owners’ equity

Problem Definition b. ROE = Net income / Average owners’ equity

Problem Solution c. Current assets $ $ $736

Problem Solution c. Current assets $ $ $736 Current liabilities (562) (803) (710)

Problem Solution c. Current assets $ $ $736 Current liabilities (562) (803) (710) Working capital (CA –CL) $ $ $ 26

Problem Solution c. Current assets $ $ $736 Current liabilities (562) (803) (710) Working capital (CA –CL) $ $ $ 26 Current ratio (CA / CL)

Problem Definition d. EPS = Net income / Weighted average number of shares outstanding

Problem Definition d. 2004 EPS = EPS = Net income / Weighted average number of shares outstanding

Problem Definition d. 2004 EPS = $192 EPS = Net income / Weighted average number of shares outstanding

Problem Definition d. 2004 EPS = $192 / 41.3 EPS = Net income / Weighted average number of shares outstanding

Problem Definition d. 2004 EPS = $192 / 41.3 = $4.65 EPS = Net income / Weighted average number of shares outstanding

Problem Definition d. 2004 EPS = $192 / 41.3 = $4.65 2003 EPS = EPS = Net income / Weighted average number of shares outstanding

Problem Definition d. 2004 EPS = $192 / 41.3 = $4.65 2003 EPS = $187 EPS = Net income / Weighted average number of shares outstanding

Problem Definition d. 2004 EPS = $192 / 41.3 = $4.65 2003 EPS = $187 / 46.7 EPS = Net income / Weighted average number of shares outstanding

Problem Definition d. 2004 EPS = $192 / 41.3 = $4.65 2003 EPS = $187 / 46.7 = $4.00 EPS = Net income / Weighted average number of shares outstanding

Problem Definition e. Price/Earnings Ratio = Market Price / Earnings Per Share

Problem Definition e. 13 = Price/Earnings Ratio = Market Price / Earnings Per Share

Problem Definition e. 13 = $??? Price/Earnings Ratio = Market Price / Earnings Per Share

Problem Definition e. 13 = $??? / $4.65 Price/Earnings Ratio = Market Price / Earnings Per Share

Problem Definition e. 13 = $??? / $4.65 Market price = Price/Earnings Ratio = Market Price / Earnings Per Share

Problem Definition e. 13 = $??? / $4.65 Market price = $60.45 Price/Earnings Ratio = Market Price / Earnings Per Share

Problem Definition f. Cash dividends per share = Total cash dividends / Weighted average shares outstanding

Problem Definition f. $50 million
Cash dividends per share = Total cash dividends / Weighted average shares outstanding

Problem Definition f. $50 million / 41.3 million

Problem Definition f. $50 million / 41.3 million = $1.21

Cash dividends per share = Total cash dividends / Weighted average shares outstanding Dividend yield = Cash dividends per share / Market price per share

$1.21 per share Cash dividends per share = Total cash dividends / Weighted average shares outstanding Dividend yield = Cash dividends per share / Market price per share

$1.21 per share / $60.45 per share Cash dividends per share = Total cash dividends / Weighted average shares outstanding Dividend yield = Cash dividends per share / Market price per share

$1.21 per share / $60.45 per share = 2% Cash dividends per share = Total cash dividends / Weighted average shares outstanding Dividend yield = Cash dividends per share / Market price per share

Problem Definition g. Dividend payout ratio = Dividends per share / Earnings per share

Problem Definition g. $1.21 per share
Dividend payout ratio = Dividends per share / Earnings per share

Problem Definition g. $1.21 per share / $4.65 per share

Problem Definition g. $1.21 per share / $4.65 per share = 26%

Problem Definition h. Average days’ sales = Annual sales / 365 days

Problem Definition h. $3,050 million
Average days’ sales = Annual sales / 365 days

Problem Definition h. $3,050 million / 365 days

Problem Definition h. $3,050 million / 365 days = $8.356 million

Average days’ sales = Annual sales / 365 days Number of days’ sales in accounts receivable = Accounts receivable / Average days’ sales

$309 million / $8.356 million Average days’ sales = Annual sales / 365 days Number of days’ sales in accounts receivable = Accounts receivable / Average days’ sales

$309 million / $8.356 million = 37.0 days Average days’ sales = Annual sales / 365 days Number of days’ sales in accounts receivable = Accounts receivable / Average days’ sales

Problem Definition i. Debt ratio = Total liabilities / (Total liabilities + owners’ equity)

Problem Definition i. 12/31/04 debt ratio = Debt ratio = Total liabilities / (Total liabilities + owners’ equity)

Problem Definition i. 12/31/04 debt ratio = ($562 + $1,521) Debt ratio = Total liabilities / (Total liabilities + owners’ equity)

Problem Definition i. 12/31/04 debt ratio = ($562 + $1,521) / $3,090 Debt ratio = Total liabilities / (Total liabilities + owners’ equity)

Problem Definition i. 12/31/04 debt ratio = ($562 + $1,521) / $3,090 = 67.4% Debt ratio = Total liabilities / (Total liabilities + owners’ equity)

Problem Definition i. 12/31/04 debt ratio = ($562 + $1,521) / $3,090 = 67.4% 12/31/03 debt ratio = Debt ratio = Total liabilities / (Total liabilities + owners’ equity)

Problem Definition i. 12/31/04 debt ratio = ($562 + $1,521) / $3,090 = 67.4% 12/31/03 debt ratio = ($803 + $982) Debt ratio = Total liabilities / (Total liabilities + owners’ equity)

Problem Definition i. 12/31/04 debt ratio = ($562 + $1,521) / $3,090 = 67.4% 12/31/03 debt ratio = ($803 + $982) / $2,811 Debt ratio = Total liabilities / (Total liabilities + owners’ equity)

Problem Definition i. 12/31/04 debt ratio = ($562 + $1,521) / $3,090 = 67.4% 12/31/03 debt ratio = ($803 + $982) / $2,811 = 63.5% Debt ratio = Total liabilities / (Total liabilities + owners’ equity)

Problem Definition i. 12/31/04 debt ratio = ($562 + $1,521) / $3,090 = 67.4% 12/31/03 debt ratio = ($803 + $982) / $2,811 = 63.5% Debt ratio = Total liabilities / (Total liabilities + owners’ equity) Debt/equity ratio = Total liabilities / Total owners’ equity

Problem Definition i. 12/31/04 debt ratio = ($562 + $1,521) / $3,090 = 67.4% 12/31/03 debt ratio = ($803 + $982) / $2,811 = 63.5% 12/31/04 debt/equity ratio = Debt ratio = Total liabilities / (Total liabilities + owners’ equity) Debt/equity ratio = Total liabilities / Total owners’ equity

Problem Definition i. 12/31/04 debt ratio = ($562 + $1,521) / $3,090 = 67.4% 12/31/03 debt ratio = ($803 + $982) / $2,811 = 63.5% 12/31/04 debt/equity ratio = ($562 + $1,521) Debt ratio = Total liabilities / (Total liabilities + owners’ equity) Debt/equity ratio = Total liabilities / Total owners’ equity

Problem Definition i. 12/31/04 debt ratio = ($562 + $1,521) / $3,090 = 67.4% 12/31/03 debt ratio = ($803 + $982) / $2,811 = 63.5% 12/31/04 debt/equity ratio = ($562 + $1,521) / $1,007 Debt ratio = Total liabilities / (Total liabilities + owners’ equity) Debt/equity ratio = Total liabilities / Total owners’ equity

Problem Definition i. 12/31/04 debt ratio = ($562 + $1,521) / $3,090 = 67.4% 12/31/03 debt ratio = ($803 + $982) / $2,811 = 63.5% 12/31/04 debt/equity ratio = ($562 + $1,521) / $1,007 = 207% Debt ratio = Total liabilities / (Total liabilities + owners’ equity) Debt/equity ratio = Total liabilities / Total owners’ equity

Problem Definition i. 12/31/04 debt ratio = ($562 + $1,521) / $3,090 = 67.4% 12/31/03 debt ratio = ($803 + $982) / $2,811 = 63.5% 12/31/04 debt/equity ratio = ($562 + $1,521) / $1,007 = 207% 12/31/03 debt/equity ratio = Debt ratio = Total liabilities / (Total liabilities + owners’ equity) Debt/equity ratio = Total liabilities / Total owners’ equity

Problem Definition i. 12/31/04 debt ratio = ($562 + $1,521) / $3,090 = 67.4% 12/31/03 debt ratio = ($803 + $982) / $2,811 = 63.5% 12/31/04 debt/equity ratio = ($562 + $1,521) / $1,007 = 207% 12/31/03 debt/equity ratio = ($803 + $982) Debt ratio = Total liabilities / (Total liabilities + owners’ equity) Debt/equity ratio = Total liabilities / Total owners’ equity

Problem Definition i. 12/31/04 debt ratio = ($562 + $1,521) / $3,090 = 67.4% 12/31/03 debt ratio = ($803 + $982) / $2,811 = 63.5% 12/31/04 debt/equity ratio = ($562 + $1,521) / $1,007 = 207% 12/31/03 debt/equity ratio = ($803 + $982) / $1,026 Debt ratio = Total liabilities / (Total liabilities + owners’ equity) Debt/equity ratio = Total liabilities / Total owners’ equity

Problem Definition i. 12/31/04 debt ratio = ($562 + $1,521) / $3,090 = 67.4% 12/31/03 debt ratio = ($803 + $982) / $2,811 = 63.5% 12/31/04 debt/equity ratio = ($562 + $1,521) / $1,007 = 207% 12/31/03 debt/equity ratio = ($803 + $982) / $1,026 = 174% Debt ratio = Total liabilities / (Total liabilities + owners’ equity) Debt/equity ratio = Total liabilities / Total owners’ equity

Problem Definition j. Times interest earned = Operating income / Interest expense

Problem Definition j. For 2004 = Times interest earned = Operating income / Interest expense

Problem Definition j. For 2004 = $296 Times interest earned = Operating income / Interest expense

Problem Definition j. For 2004 = $296 / $84 Times interest earned = Operating income / Interest expense

Problem Definition j. For 2004 = $296 / $84 = 3.5 times Times interest earned = Operating income / Interest expense

Problem Definition j. For 2004 = $296 / $84 = 3.5 times For 2003 = Times interest earned = Operating income / Interest expense

Problem Definition j. For 2004 = $296 / $84 = 3.5 times For 2003 = $310 Times interest earned = Operating income / Interest expense

Problem Definition j. For 2004 = $296 / $84 = 3.5 times For 2003 = $310 / $65 Times interest earned = Operating income / Interest expense

Problem Definition j. For 2004 = $296 / $84 = 3.5 times For 2003 = $310 / $65 = 4.8 times Times interest earned = Operating income / Interest expense

Problem Definition A young, single professional would probably be more interested in potential growth of capital rather than current dividend income, and would probably be willing to invest in a stock that represented a relatively risky investment. Based on these criteria, the significant growth in earnings per share and the relatively high financial leverage could make this stock an attractive, though risky, potential investment. (continued)

Problem Definition k. The liquidity of the company is relatively low, based on an “average” current ratio of Without further information about the composition of current assets and current liability accounts, it is difficult to assess the firm’s liquidity. The number of days’ sales in accounts receivable indicates that the accounts receivable are relatively current, assuming that the credit terms are net 30. (continued)

Problem Definition (concluded)
The company’s ROI is relatively low, and the two-year trend is down. This would be a major concern, and the reasons for this situation would be sought. The price/earnings ratio of 13 is typical for a firm with a falling ROI; the fact that the P/E ratio has remained within the “normal” range may indicate that future earnings prospects for the firm are fairly strong.

You should now have a better understanding of ratio analysis.
Accounting What the Numbers Mean 6e You should now have a better understanding of ratio analysis. Remember that there is a demonstration problem for each chapter that is here for your learning benefit. David H. Marshall Wayne W. McManus Daniel F. Viele

Demonstration Problem

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