Managerial Finance – Chapter 4

Homework 4

P3-9 Answer:

Initial sales price = (Par value of common stock + Paid in capital in excess of Par) / number of common
shares outstanding

Initial sales price = (200 +2,600) / 400 = 7

P3-10 Answer:

a.
Hayes Enterprises
Statement of RE for the year ended December 31, 2015

Retained earnings as at January 1, 2015 928,000

Net profit after taxes 377,000
Preferred stock dividend (47,000)
Common stock dividend (210,000) Note
Retained earnings as at December 31, 2015 1,048,000

b. EPS = (Net profit after taxes – Preferred Dividends) / Number of common shares outstanding
EPS = (377,000 – 47,000) / 140,000 = 2.36
c. Cash dividend per share = Total cash dividend / number of shares
Cash dividend per share = 210,000 / 140,000 = 1.5

P3-12 Answer:

a. All of the listed companies are operating in different industries. Each industry has its specific
characteristics and ratios changes due to these characteristics. Thus, it is not wise to compare
companies from different industries as this comparison will give significant deviations, which are
explained only by the specifications of the industry.
b. The lower current and quick ratios for utility and fast food companies are due to their business
model. In these industries, operations are mainly held on a cash basis and lower levels of
inventory and receivables are maintained unlike software (where a high level of AR might be
maintained) and motor (where a high level of inventory might be maintained) industries.
c. The software industry experiences high competition as it is relatively simple for new companies
to enter the market, while in the electricity sector, there are high penetration barriers such as
license, equipment and so on. In the software business, the market changes relatively quickly,
thus, there are more uncertainties that might not be favorable for the company. Accordingly, a
high debt level in a software company can raise an alert while it is not as much concern for the
utility industry.
 d. Please refer to the previous answer with regards to uncertainties. In addition, it is well-known
fact that diversification of investment portfolio is the best decision to mitigate the risk and
maximize the profit in different circumstances.

P3-17 Answer:

a. The inventory turnover ratio for Bluegrass Natural Foods Icn. is 6.0 while the industry average is
10.4. The low inventory turnover ratio indicates inefficiency – inventories are stored in the
warehouse which causes additional expenses and does not generate revenue. Either the company
is not able to sell this inventory or inventory management is poor. Thus, it means that the
company is not managing its resources efficiently. More capital is tied up in inventory than is
needed and it will take a long time to sell the products and make a profit.
b. The average collection period of AR is 73 days when the industry average is 52 days. This means
that the debtors of the company are not liquid and take too long to make the payment in
comparison with the company’s peer group. The company may grant longer payment terms in
order to increase sales revenue, but there is a risk that debtors may not be able to pay liabilities
towards Bluegrass Natural Foods and it may result in difficulties in covering its own short-term
liabilities.
c. The average payment period of the company is 31 days while the industry average is 40 days.
This means that the company does not take advantage of the credit terms allowed by the
creditors. The company pays its creditors faster than required. In that way, they maintain
supplier goodwill, but for cash management purposes it may be more reasonable to take
advantage of credit terms and use spare funds for more efficient or profitable ways.
d. The main objective of our recommendations will be to achieve desirable results and to have at
least as good results as their competitors have. For this, the company should improve its
inventory turnover ratio and liquidity ratios. The company should reduce the level of inventory
held by reducing production or increasing sales. Obsolete and impaired inventory should be
written down. In addition, they should try to make their customers pay earlier. The company can
use promotions to stimulate on-time payments. Bluegrass Natural Foods Inc should also slow
their payment to suppliers as terms allow them so and try to use available funds more effectively.
Recommendations might not be effective as they might cause loss of customers’ or suppliers’
goodwill.

P3-20 Answer:

According to the income statements of Creek Enterprises, sales revenue decreased by 14% in comparison
with PY, while the cost of goods sold as a percentage of sales increased and gross profit margin decreased
accordingly. This might be productive inefficiency or increased prices on raw materials. Operating
expenses as a percent of sales decreased which is good is it is not related to decreased sales revenue.
Interest expense as a percentage of sales almost doubled in comparison with PY and must be related to
the increased debt level in the current year.

Further analysis and investigation might be required for the high level of debt and increased cost of
goods sold.