Solutions Manual for Financial Statement Analysis and Valuation 3rd Edition By Easton‏ (All Chapters, 100% Original Verified, A+ Grade)

 

CLICK TO ACCESS: Solutions Manual for Financial Statement Analysis and Valuation 3rd Edition By Easton‏ 

Module 1

Framework for Analysis and Valuation

DISCUSSION QUESTIONS

Q1-1. Organizations undertake planning activities that shape three major

activities: financing, investing, and operating. Financing is the

means a company uses to pay for resources. Investing refers to

the buying and selling of resources necessary to carry out the

organization’s plans. Operating activities are the actual carrying

out of these plans. Planning is the glue that connects these

activities, including the organization’s ideas, goals and strategies.

Financial accounting information provides valuable input into the

planning process, and, subsequently, reports on the results of

plans so that corrective action can be taken, if necessary.

Q1-2. An organization’s financing activities (liabilities and equity =

sources of funds) pay for investing activities (assets = uses of

funds). An organization’s assets cannot be more or less than its

liabilities and equity combined. This means: assets = liabilities +

equity. This relation is called the accounting equation (sometimes

called the balance sheet equation), and it applies to all

organizations at all times.

Financial Statement Analysis and Valuation 3e Easton (Solutions

Manual All Chapters, 100% Original Verified, A+ Grade)

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1-2 Financial Statement Analysis & Valuation, 3rd Edition

Q1-3. The four main financial statements are: income statement, balance

sheet, statement of stockholders’ equity, and statement of cash

flows. The income statement provides information about the

company’s revenues, expenses and profitability over a period of

time. The balance sheet lists the company’s assets (what it owns),

liabilities (what it owes), and stockholders’ equity (the residual

claims of its owners) as of a point in time. The statement of

stockholders’ equity reports on the changes to each stockholders’

equity account during the period. The statement of cash flows

identifies the sources (inflows) and uses (outflows) of cash, that

is, where the company got its cash from and what it did with it.

Together, the four statements provide a complete picture of the

financial condition of the company.

Q1-4. The balance sheet provides information that helps users

understand a company’s resources (assets) and claims to those

resources (liabilities and stockholders’ equity) as of a given point

in time.

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Q1-5. The income statement covers a period of time. An income

statement reports whether the business has earned a net income

(also called profit or earnings) or incurred a net loss. Importantly,

the income statement lists the types and amounts of revenues and

expenses making up net income or net loss.

Q1-6. The statement of cash flows reports on the cash inflows and

outflows relating to a company’s operating, investing, and

financing activities over a period of time. The sum of these three

activities yields the net change in cash for the period. This

statement is a useful complement to the income statement, which

reports on revenues and expenses, but which conveys relatively

little information about cash flows.

Q1-7. Retained earnings (reported on the balance sheet) is increased

each period by any net income earned during the period (as

reported in the income statement) and decreased each period by

the payment of dividends (as reported in the statement of cash

flows and the statement of stockholders’ equity). Transactions

reflected on the statement of cash flows link the previous period’s

balance sheet to the current period’s balance sheet. The ending

cash balance appears on both the balance sheet and the statement

of cash flows.

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Solutions Manual, Module 1 1-3

Q1-8. External users and their uses of accounting information include:

(a) lenders for measuring the risk and return of loans; (b)

shareholders for assessing the return and risk in acquiring shares;

and (c) analysts for assessing investment potential. Other users

are auditors, consultants, officers, directors for overseeing

management, employees for judging employment opportunities,

regulators, unions, suppliers, and appraisers.

Q1-9. Forecasting is a method of formally expressing our expectations

of a company's future payoffs. When forecasting company

payoffs, we need to consider the effects of their business

environment on the company's ability to achieve those future

payoffs. Competitive forces as well as opportunities and threats

will impact what the company can pay in the future. This in turn

affects what payoffs are expected. A better understanding of

business environment and accounting information leads to more

accurate forecasts of the future and more reliable valuation

estimates.

Q1-10.A Procter & Gamble’s independent auditor is Deloitte & Touche LLP.

The auditor expressly states that “our responsibility is to express

an opinion on these financial statements based on our audits.”

The auditor also states that “these financial statements are the

responsibility of the company’s management.” Thus, the auditor

does not assume responsibility for the financial statements.

Q1-11.B While firms acknowledge the increasing need for more complete

disclosure of financial and nonfinancial information, they have

resisted these demands to protect their competitive position.

Corporate executives must weigh the benefits they receive from

the financial markets as a result of more transparent and revealing

financial reporting against the costs of divulging proprietary

information to competitors and others.

Q1-12.B Generally Accepted Accounting Principles (GAAP) are the various

methods, rules, practices, and other procedures that have evolved

over time in response to the need to regulate the preparation of

financial statements. They are primarily set by the Financial

Accounting Standards Board (FASB), a private sector entity with

representatives from companies that issue financial statements,

accounting firms that audit those statements, and users of

financial information. Other bodies that contribute to GAAP are the

AICPA, the EITF, and the SEC.

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1-4 Financial Statement Analysis & Valuation, 3rd Edition

Q1-13.B Corporate governance is the system of policies, procedures and

mechanisms that protect the interests of stakeholders in the

business. These stakeholders include investors, creditors,

regulatory bodies, and employees, to name a few. Sound

corporate governance involves the maintenance of an effective

internal auditing function, an independent and effective external

auditing function, an informed and impartial board of directors,

governmental oversight (such as from the SEC), and the oversight

of the courts.

Q1-14.B The auditor’s primary function is to express an opinion as to

whether the financial statements fairly present the financial

condition of the company and are free from material

misstatements. Auditors do not prepare the financial statements;

they only audit them and issue their opinion on them. The

auditors provide no guarantees about the financial statements or

about the company’s continued performance.

Q1-15. Financial accounting information is frequently used in order to

evaluate management performance. The return on equity (ROE)

and return on assets (ROA) provide useful measures of financial

performance as they combine elements from both the income

statement and the balance sheet. Financial accounting information

is also frequently used to monitor compliance with external

contract terms. Banks often set limits on such items as the

amount of total liabilities in relation to stockholders’ equity or the

amount of dividends that a company may pay. Audited financial

statements provide information that can be used to monitor

compliance with these limits (often called covenants). Regulators

and taxing authorities also utilize financial information to monitor

items of interest.

Q1-16. Managers are vitally concerned about disclosing proprietary

information that might benefit the company’s competitors. Of most

concern, is the “cost” of losing some competitive advantage.

There has traditionally been tension between companies and the

financial professionals (especially investment analysts) who press

firms for more and more financial and nonfinancial information.

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Solutions Manual, Module 1 1-5

Q1-17. Net income is an important measure of financial performance. It

indicates that the market values the company’s products or

services, that is, it is willing to pay a price for the products or

services enough to cover the costs to bring them to market and to

provide the company’s investors with a profit. Net income does

not tell the whole story, however. A company can always increase

its net income with additional investment in something as simple

as a bank savings account. A more meaningful measure of

financial performance comes from measuring the level of net

income relative to the investment made. One investment measure

is the balance of stockholders’ equity, and the comparison of net

income to average stockholders’ equity (ROE) is a fundamental

measure of financial performance.

Q1-18. Borrowed money must be repaid, both the principal amount

borrowed, as well as interest on the borrowed funds. These

payments have contractual due dates. If payments are not prompt,

creditors have powerful legal remedies, including forcing the

company into bankruptcy. Consequently, when comparing two

companies with the same return on equity, the one using less debt

would generally be viewed as a safer (less risky) investment.

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1-6 Financial Statement Analysis & Valuation, 3rd Edition

MINI EXERCISES

M1-19 (10 minutes)

($ millions)

Assets = Liabilities + Equity

$38,599 $30,833 $7,766

Dell receives more of its financing from nonowners ($30,833 million) than

from owners ($7,766 million). Its owner financing comprises 20.1% of its

total financing ($7,766 million/ $38,599 million). Thus, nonowners finance

79.9% of Dell’s total assets.

M1-20 (10 minutes)

($ millions)

Assets = Liabilities + Equity

$17,849 $10,557 $7,292

Best Buy receives more of its financing from nonowners ($10,557 million)

than from owners ($7,292 million). Its owner financing comprises 40.9% of

its total financing ($7,292 million/ $17,849 million).

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Solutions Manual, Module 1 1-7

M1-21 (15 minutes)

($ millions) Assets = Liabilities + Equity

Hewlett-Packard $124,503 $83,722 (a) $40,781

General Mills $18,674 (b) $12,062 $6,612

Target (c) $43,705 $28,218 $15,487

The percent of owner financing for each company follows:

Hewlett-Packard ..................... 32.8% ($40,781 million / $124,503 million)

General Mills ........................... 35.4% ($6,612 million / $18,674 million)

Target ...................................... 35.4% ($15,487 million / $43,705 million)

General Mills and Target are more owner financed, while Hewlett-Packard is

more nonowner financed, but all are financed with roughly the same level

of debt and equity. All three enjoy relatively stable cash flows and can,

therefore, utilize a greater proportion of debt vs. equity. As the uncertainty

of cash flows increases, companies generally substitute equity for debt in

order to reduce the magnitude of contractual payment obligations.

M1-22A (15 minutes)

In its October 2010 annual report, Starbucks reports the following figures

(in $ millions):

Assets = Liabilities + Equity

$ 6,385.9 = $ 2,703.6 + $ 3,682.3

As shown, the accounting equation holds for Starbucks. Also, we can see

that Starbucks’ nonowner financing is 42.3% ($2,703.6 / $6,385.9) of its total

financing.

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1-8 Financial Statement Analysis & Valuation, 3rd Edition

M1-23A (20 minutes)

DuPont

Statement of Reinvested Earnings

For Year Ended December 31, 2010

Beginning reinvested earnings, December 31, 2009...................... $ 10,710

Net income for 2010........................................................................... 3,031

Common stock dividends ................................................................. (1,500)

Preferred stock dividends................................................................. (10)

Treasury stock retirement* ............................................................... (201)

Ending reinvested earnings, December 31, 2010 ........................... $ 12,030

* Treasury Stock represents the company’s repurchase of Common Stock. The effect is to

decrease stockholders’ equity, which is the opposite effect from the issuance of stock.

During 2010, DuPont retired Treasury Stock and will not reissue these shares again. This

transaction reduced the company’s retained earnings but did not affect net income for the

year.

M1-24 (20 minutes)

a. BS and SCF d. BS and SE g. SCF and SE

b. IS e. SCF h. SCF and SE

c. BS f. BS and SE i. IS, SE, and SCF

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CLICK TO ACCESS: Solutions Manual for Financial Statement Analysis and Valuation 3rd Edition By Easton‏ 

Solutions Manual, Module 1 1-9

M1-25 (10 minutes)

There are many stakeholders impacted by this business decision, including

the following (along with a description of how):

• You as a Manager—your reputation, self-esteem, and potentially your

livelihood could be negatively impacted.

• Creditors and Bondholders—credit decisions based on inaccurate

information could occur.

• Shareholders—buying or selling shares based on inaccurate

information could occur.

• Management and other Employees of your company—repercussions of

your decision extend to all other employees. Also, a decision to record

these revenues suggests an environment condoning dishonesty.

Indeed, your decisions can affect many more parties than you might

initially realize. The short-term benefit of meeting Wall Street’s

expectations could have serious long-term ramifications.

M1-26B (10 minutes)

Internal controls are designed for the following purposes:

• Monitoring an organization’s activities to promote efficiency and to

prevent wrongful use of its resources

• Ensuring the validity and credibility of external accounting reports

• Promoting effective operations

• Ensuring reliable internal reporting

Congress has a special interest in internal controls and reports about

them. Specifically, the absence or failure of internal controls can adversely

affect the effectiveness of domestic and global financial markets. Enron

provided Congress with a case in point.

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1-10 Financial Statement Analysis & Valuation, 3rd Edition

EXERCISES

E1-27 (15 minutes)

a. Target has a proprietary credit card (the Target Card). Customers’

unpaid credit card balances at the end of the reporting period are similar

to accounts receivable.

b. Target’s inventories consist of the product lines it carries: clothing,

electronics, home furnishings, food products, and so forth.

c. Target’s PPE assets consist of land, buildings, store improvements

such as lighting, flooring, HVAC, store shelving, shopping carriages,

and cash registers.

d. Although Target sells some of its merchandise via its Website, the

majority of its sales activity is conducted in its retail locations. These

stores represent a substantial and necessary capital investment for its

business model.

E1-28 (20 minutes)

($ millions)

a. Using the accounting equation:

Assets ($63,186) = Liabilities ($13,756) + Equity (?)

Thus: $49,430 = Equity

High-tech companies must contend with a substantial amount of risk

relating to changing technology. Future cash flows are, therefore, not

as certain and cannot support high levels of debt. Thus, the company

uses equity financing; 78.2% in the case of Intel.

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Solutions Manual, Module 1 1-11

E1-28 (concluded)

b. Using the accounting equation at the beginning of the year:

Assets ($6,549) = Liabilities (?) + Equity ($1,546)

Thus: Beginning Liabilities = $5,003

Using the accounting equation at the end of the year:

Assets ($6,549 + $44) = Liabilities ($5,003 - $64) + Equity (?)

Thus: Ending Equity = $1,654

Alternative approach to solving part (b):

DAssets($44) = DLiabilities($-64) + DEquity(?)

where “D” refers to “change in.”

Thus: D Ending Equity = $44 - $-64 = $108 and

Ending equity = $1,546 + $108 = $1,654

c. Retained Earnings is the balance sheet account that provides the link

between the balance sheet and the income statement. Each accounting

period, Retained Earnings is updated by the net income (loss) reported

for that period (and is reduced by any dividends that are paid to

shareholders). The balance sheet and the income statement are,

therefore, linked by this balance sheet account.