Solution manual introduction to management accounting 14e by horngren ch17

To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CHAPTER 17 COVERAGE OF LEARNING OBJECTIVES LEARNING OBJECTIVE LO1: Contrast accounting for investments using the equity method and the market-value method LO2: Explain the basic ideas and methods used to prepare consolidated financial statements LO3: Describe how goodwill arises and how to account for it LO4: Explain and use a variety of popular financial ratios LO5: Identify the major implications that efficient stock markets have for accounting LO6: Explain and illustrate four methods of measuring income: historical cost/nominal dollars, current cost/nominal dollars, historical cost/constant dollars, and current cost/constant dollars (Appendix 17) EXCEL, FUNDAMENTAL ADDITIONAL COLLAB., ASSIGNMENT ASSIGNMENT & MATERIAL MATERIAL INTERNET EXERCISES A1, B1, B3 26, 29, 40, 41 55 49 A2, A3, B2 25, 30, 32, 34 35, 39, 40, 42 43, 44, 49 52 A4 31, 32, 33, 45 46 A5, B4, B5 27, 36, 47, 48 28, 37, 38, 50, 51 971 55 53, 54,55 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CHAPTER 17 Understanding and Analyzing Consolidated Financial Statements 17-A1 (15-20 min.) Answers are in millions of dollars Equity Method Assets = Liab + Stk Eq Invest- Liabil- Stock Cash ments ities Equity a Acquisition -68 +68 = b Net income of Akron +12 = +12 c Dividends from Akron + - = Effects for year -61 +73 = +12 The journal entries that would accompany this table are: a Investment in Akron Cash 68 b Investment in Akron Investment revenue* 12 c Cash Investment in Akron 68 12 * More frequently called Equity in Earnings of Affiliates 972 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Under the equity method, Reo Motors recognizes income as Akron earns it rather than when Reo receives dividends Cash dividends not affect net income; they increase cash and decrease the investment balance In a sense, the dividend is a partial liquidation of the investor's "claim" against the investee The receipt of a dividend is similar to the collection of an account receivable The revenue from a sale of merchandise on account is recognized when the receivable is created; to include the collection also as revenue would be double-counting Similarly, it would be double-counting to include the $7 million of dividends as income after the $12 million of income is already recognized as it is earned Market-Value Method Assets = Liab + Stk Eq Invest- Liabil- Stock Cash ments ities Equity a Acquisition -68 +68 = b Dividends from Akron + = +7 (Revenue) c Increase in market value +8 = + (Other comprehensive income) Effects for year -61 +76 = +15 The journal entries that would accompany this table are: a Investment in Akron Cash 68 68 b Cash Dividend revenue** 7 c Investment in Akron Unrealized gain on available-for-sale securities ** Frequently called "dividend income" 973 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 17-A2 (25-35 min.) A common mistake is to think that the $50 million is additional money flowing into the Calgary Company rather than into the pockets of the Calgary shareholders as individuals Amounts are in millions Assets =Liab.+ Stockholders' Equity Investment Cash Accounts in and Other Payable, Stockholders' Calgary + Assets = etc + Equity Alberta’s accounts, Jan 1: Before acquisition Acquisition of Calgary +50 Calgary’s accounts, Jan Intercompany eliminations -50 Consolidated, Jan Sales Expenses Operating income Pro-rata share (100%) of unconsolidated subsidiary net income Net income 350 - 50 70 + 370 = = = = = Alberta Calgary $330 $100 245 90 $ 85 $ 10 10 $ 95 974 $ 10 110 + 240 20 + 130 + 50 - 50 240 Consolidated $430 335 $ 95 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Alberta’s parent-company-only income statement would show its own sales and expenses plus its pro-rata share of Calgary's net income, as the equity method requires Reflect on the changes in Alberta’s balance sheet equation (in millions): Assets = Liab.+Stockholders' Equity InvestCash ment and Accounts in Other Payable, Stockholders' Calgary + Assets = etc + Equity Alberta’s accounts: Beginning of the year 50 + 300 = 110 + 240 Operating income + 85 = + 85 Share of Calgary's income +10 = + 10 End of year 60 + 385 = 110 + 335 Calgary's accounts: Beginning of the year 70 = 20 + 50 Net income + 10 = + 10 End of the year 80 = 20 + 60 Intercompany eliminations -60 = - 60 Consolidated, end of year + 465 = 130 + 335 Calgary’s balance sheet accounts would have increased by $10 million At this point, review to see that consolidated statements are the summation of the individual accounts of two or more separate legal entities These statements are prepared periodically via worksheets A consolidated entity does not have a separate continuous set of books like its legal entities Moreover, a consolidated income statement is merely the summation of the revenue and expenses of the separate legal entities being consolidated after the elimination of double-counting 975 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Consolidated accounts would be unaffected Calgary’s cash and stockholders' equity would decline by $7 million Alberta’s investment in Calgary would decline by $7 million, but Alberta’s cash would rise by $7 million 17-A3 (30-45 min.) A common error is to think that the $40 million is additional money flowing into the Calgary Company rather than into the pockets of the Calgary shareholders Amounts are in millions Assets InvestCash ment and in Other Calgary + Assets = Liab.+Stockholders' Equity Accounts Payable, Minority Stockholders' = etc +Interest + Equity Alberta’s accounts, Jan 1: Before acquisition 350 = Acquisition of Calgary +40 - 40 = Calgary’s accounts, Jan 70 = Intercompany eliminations -40 = Consolidated, Jan + 380 = 110 + 240 20 + 50 - 50 240 +10 130 + 10 + The same basic procedures are followed by Alberta and Calgary regardless of whether Calgary is 100% owned or 80% owned However, the presence of a minority interest changes the consolidated statements slightly The income statements would include: 976 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Alberta Calgary $330 $100 245 90 $ 85 $ 10 Sales Expenses Operating income Pro-rata share (80%) of unconsolidated subsidiary net income Net income $ 93 Minority interest (20%) in consolidated subsidiaries' net income Net income to consolidated entity Assets InvestCash ment and in Other Calgary + Assets Alberta’s accounts: Beginning of year Operating income Share of Calgary's income End of year Calgary’s accounts: Beginning of year Net income End of year Intercompany eliminations Consolidated, end of year $ 10 $ 93 = Liab.+Stockholders' Equity Accounts Payable, Minority Stockholders' = etc +Interest + Equity 40 + 310a = + 85 = +8 48 = + 395 = 70 + 10 80 -48 + 475 a = = = = = 350 beginning of year - 40 for acquisition = 310 10 beginning of year + 20(10) = 10 + = 12 b 977 Consolidated $430 335 $ 95 110 + 110 + 20 + 20 + b + 12 130 + 12 + 240 + 85 + 333 50 + 10 60 - 60 333 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Consolidated accounts would be affected because the minority interest's claim would be partially liquidated in the amount of 20% of $7 million, or $1.4 million Calgary’s cash would decline by $7 million, Alberta’s investment in Calgary would decline by 80 x $7 million = $5.6 million, but Alberta’s cash would rise by $5.6 million See following balance sheet equations: Assets InvestCash ment and in Other Calgary +Assets End of year balances: Alberta’s accounts 48.0 + Effect of Calgary dividend - 5.6 Balance 42.4 + Calgary’s accounts (from 3): Effect of Calgary dividend Balance Consolidated accounts 42.4 Intercompany eliminations-42.4 Balance + = Liab.+Stockholders' Equity Accounts Payable, Minority Stockholders' = etc +Interest + Equity 395.0 = 110 + 333 + 5.6 = 400.6 = 110 + 333 20 + 20 130 + + 60 - 53 386 - 53 333 80.0 = - 7.0 = 73.0 = 473.6 = = 473.6 = 978 +10.6 130 + 10.6 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 17-A4 (25-35 min.) Assets =Liab.+Stockholders' Equity InvestCash ment and Accounts in Good- Other Payable, Stockholders' Calgary + will +Assets = etc + Equity Alberta’s accounts, Jan 1: Before acquisition 350 Acquisition of 100% of Calgary +80 - 80 Calgary’s accounts, Jan 70 Intercompany eliminations - 80 +30 Consolidated, Jan + 30*+ 340 = 110 + 240 20 + 50 - 50 240 = = = = 130 * The $30 million "goodwill" would appear in the consolidated balance sheet as a separate intangible asset account It often is shown as the final item in a listing of assets It remains on the books until its value is impaired a If the book values of the Calgary’s individual assets are not equal to their fair values, the usual procedures are: (1) Calgary continues as a going concern and keeps its accounts on the same basis as before (2) Alberta records its investment at its acquisition cost (the agreed purchase price) (3) For consolidated reporting purposes, the excess of the acquisition cost over the book values of Calgary is identified with the individual assets, item by item (In effect, they are revalued at the current market prices prevailing when Alberta acquired Calgary.) Any remaining excess that cannot be identified is labeled as purchased goodwill 979 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com The balance sheet accounts immediately after acquisition would be the same as in Requirement 1, except that goodwill would be $18 million instead of $30 million (that is, $27 million - $15 million = $12 million less), and other assets would be higher by $12 million The $12 million would appear in the consolidated balance sheet as an integral part of the "other assets." That is, Calgary’s equipment would be shown at $12 million higher in the consolidated balance sheet than the carrying amount on Calgary’s books Similarly, the depreciation expense on the consolidated income statement would be higher For instance, if the equipment had four years of useful life remaining, the straight-line depreciation would be $12 ÷ = $3 million higher per year As in the preceding tabulation, the $18 million "goodwill" would appear in the consolidated balance sheet as a separate intangible asset account b Consolidated income would be lower by the amount of depreciation on the additional individual assets: Extra annual depreciation, $12,000,000 ÷ years = $3,000,000 The assigning of a "basket purchase price" to the various assets can have a dramatic effect on income Every dollar assigned to individual assets rather than goodwill will become an expense sometime, but dollars assigned to goodwill might remain indefinitely on the books unless the value of the goodwill becomes impaired 980 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 17-39 (5-10 min.) Generally the last item under long-term liabilities Sometimes a part of stockholders' equity Current liability Investments section of long-term assets Current asset Current liability Deduction from total stockholders' equity 17-40 (10 min.) The first two items indicate that there are minority shareholders in the subsidiaries, whose individual sales, assets, and other detailed accounts have been added together in the DuPont consolidated statements The minority interests' share of earnings appears in the income statement; the other account usually appears among "other liabilities" on the balance sheet The last two items summarize DuPont's investments in affiliated (or associated) companies The first appears under longterm assets in the balance sheet, and the second generally appears under “other income” in the income statement 1008 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 17-41 (15 min.) ConocoPhillips recognized $3,457 million of income from the affiliated companies The amount of dividends paid by the investees is irrelevant to computing ConocoPhillips’s income This was 15% of ConocoPhillips’s pretax income ConocoPhillips invested $3,661 million in equity method investment in 2005 The balance sheet equation and Taccount summaries are shown below (in millions of dollars): Equity Method Investments Beg Bal 9,466 Income +3,457 Dividends -1,807 New Investment + X End Bal 14,777 Equity Method Investments Beg Bal 9,466 Income 3,457 Dividends 1,807 Add Inv X End Bal 14,777 $9,466 + $3,457 - $1,807 + X = $14,777 X = $ 3,661 The income recognized would remain at $3,457 million The amount of dividends paid by investees does not affect the parent’s income 1009 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 17-42 (5-10 min.) The parent company could not easily achieve the windowdressing of income under the equity method For example, if the subsidiary were wholly owned, the parent's share of subsidiary losses would be 100% and would be completely reflected in the parent's accounts That is why the equity method is often called a "one-line consolidation." However, a possibility for windowdressing is to sell assets (including inventories) to the subsidiary at inflated prices Until the subsidiary sells or uses the assets, the parent company’s income (including its share of the subsidiary’s income) will be higher 17-43 (20 min.) Amounts are in billions ¥1,886 – ¥681 = ¥1,205 or ¥1,162 + 43 = ¥1,205 Let X = subsidiaries’ net income 10 x X = ¥43 X = ¥430 ¥505 - ¥43 = ¥462 1010 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 17-44 (15 min.) Amounts are in millions $10,567 million loss; the GM income (loss) would not change - $10,567 million - $2,394 million = $12,961 million loss The consolidated statement allows a comprehensive look at the financial results of the entire entity owned by the shareholders of General Motors For example, it would combine the amount of goods and services sold to customers of General Motors and GMAC The unconsolidated statement does not show all of these revenues Similarly, the unconsolidated statement does not show all the individual expenses because those of GMAC are offset against its revenues when the single line, earnings of nonconsolidated affiliates, is included in the General Motors unconsolidated statement In contrast, the unconsolidated statements avoid combining assets, liabilities, revenues, and expenses for totally different types of operations (e.g., auto production and lending money) Some critics of consolidation maintain that adding the accounts of such unlike operations is like adding apples and oranges it may make numerical sense but it does not make economic sense 1011 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 17-45 (10-15 min.) Goodwill = $53.4 billion – ($29.7 billion + $10.0 billion – $21.2 billion) = $34.9 billion This entire amount will stay on P&G’s balance sheet until the value of the goodwill has decreased (or been impaired) Goodwill would have been $34.9 billion + $29.7 billion = $64.6 billion, which would remain on the books until it is impaired In contrast, P&G would amortize the $29.7 billion of identifiable intangible assets over an average of 10 years, resulting in amortization of $29.7 billion ÷ 10 = $2.97 billion per year Thus, operating income will be less by $2.97 billion if P&G treats the $29.7 billion as specific intangible assets A manager might prefer to have this as goodwill and avoid an amortization charge in future years This will serve to increase the reported income in these years Offsetting this is the need to write off some or all of the $34.9 billion if the goodwill should become impaired 17-46 (15-20 min.) Amounts are in millions Goodwill would equal the purchase price less the fair value of the intangible assets less the fair value of the net tangible assets: Goodwill = $65.1 million – $22.3 million - ($3.6 million – $2.3 million) = $41.5 million 1012 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Consolidated net income is the Medtronic net income plus (minus) the IGN net income (loss) less the amortization of the intangible assets, which is $22.3 million ÷ 12 = $1.9 million Therefore, Consolidated net income = $2,546.7 million - $10.0 million - $1.9 million = $2,534.8 million There would be no depreciation of the intangible assets Assuming no impairment of goodwill, the consolidated net income would be: $2,546.7 million - $10.0 million = $2,536.7 million 17-47 (10-20 min.) Dollar amounts are in millions Average assets: ($1,988,968 + $1,637,153) ÷ = $1,813,060.5 Net income percentage of average assets: $136,567 ÷ $1,813,060.5= 7.532% Total revenues: $136,567 ÷ 05144 = $2,654,879 Average stockholders' equity: $136,567 ÷ 16003 = $853,384 Asset turnover: (a) $2,654,879 ÷ $1,813,060.5= 1.46 (b) 7.532% ÷ 5.144% = 1.46 1013 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 17-48 (15-20 min.) Monetary amounts are in billions of yen HONDA MOTOR COMPANY Income Statement For the Year Ended March 31, 2006 Net sales Cost of sales Gross profit Selling and administrative expenses Research and Development Operating income Other income (expense): Interest income Interest expense Other Earnings before income taxes Income taxes Net income Amount Percentage ¥9,908100.0% 7,010 70.8 2,898 29.2 1,656 16.7 510 5.1 732 7.4 27 (12) 167 914 317 ¥ 597 0.3 (0.1) 1.7 9.2 3.2 6.0% a Current ratio= Current assets ữ Current liabilities = Ơ4,626 ữ ¥3,989 = 1.16 b Total debt to equity = Total liabilities ữ Stockholders' equity = (Ơ3,989 + Ơ2,457) ữ Ơ4,126 = 156.2% c Gross profit rate = Gross profit ÷ Sales = Ơ2,898 ữ Ơ9,908 = 29.2% Note that the gross profit rate is shown in the common-size income statement 1014 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com d Return on stockholders' equity = Net income ữ Avg stockholders' equity = Ơ597 ữ 1/2(Ơ4,126 + ¥3,289) = 16.1% e Price-earnings ratio = Market price per share ữ Earnings per share = Ơ3,600 ữ Ơ649 = 5.5 g Dividend-payout ratio = Dividends per share ÷ Earnings per share = Ơ77 ữ Ơ649 = 11.9% These ratios themselves are difficult to interpret Comparisons are necessary It would be helpful to know Honda’s ratios for the past few years to aid the identification of trends It would also be helpful to have average industry ratios for comparison General benchmarks for Japanese rather than U.S firms would also be useful 1015 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 17-49 (15-20 min.) Because Medusa Electronics accounts for its 19% investment in Taylor Transport using the market-value method, and because the securities are available-for-sale securities, changes in the market value of Taylor are entered directly into stockholders’ equity They are not included in the income statement In contrast, the amount of dividends paid by Taylor are part of the income of Medusa Electronics Thus, regardless of what happens to the market value of Taylor, Medusa will include only Taylor’s dividends in income By increasing the Taylor dividends, Medusa will increase its net income This illustrates the principle that the FASB uses to govern whether the equity method should be used The requirement is that an investment be accounted for under the equity method whenever the investee firm has “significant influence.” The usual indicator of significant influence is percentage ownership, where ownership of 20% or more creates the presumption of influence However, the presumption can be overcome by other evidence of significant influence The fact that Medusa was able to influence dividend policy so dramatically suggests that Medusa has significant influence over the investee, Taylor, and therefore should account for the investment in Taylor using the equity method Note that under the equity method, the extra dividend will not be included in Medusa’s income 1016 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com At least two ethical issues arise First is the investment by Medusa in Taylor If the decision was made by Jamil Johnson based only on his friendship with Max Taylor, and if it was not in the best interests of the shareholders of Medusa, Johnson was not appropriately carrying out his duties as an officer of Medusa Presently this may not be of much concern because the investment appears to have turned out to be profitable to the Medusa shareholders Nevertheless, if the decision had been based on predicted personal rather than corporate benefits, it was not appropriate Second is the influence of Johnson on Taylor’s dividend policy Not only does this manipulation of Taylor’s policy violate the intent of the accounting principles, it may not be in the best interests of Taylor’s other shareholders (i.e., those shareholders other than Medusa) If Taylor pays out $4 million in dividends and then borrows to meet its capital needs, future profitability of Taylor may be diminished The personal obligation of Taylor to Johnson should not influence the corporate decisions On the other hand, Taylor and Medusa may be essentially forming an implicit strategic alliance When one company needs special help, the other is willing to provide it Companies in Japan have had such alliances for years, and they have worked well Often it is hard to judge the ethical implications of actions without being able to assess intent Still, this situation at least possesses the appearance of possible ethical violations 1017 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 17-50 (15-20 min.) Historical Current Historical Current Cost/ Cost/ Cost/ Cost/ Nominal Nominal Constant Constant Dollars Dollars Dollars Dollars (In millions) (a) Beginning inventory $2,345.2 (b) Ending inventory (c) Cost of goods sold (d) Holding gains (losses): On units sold On units unsold Gross margin $2,132.0 2,466.0 1,066.0 $2,132.0 $2,345.2 2,800.0 1,400.0 2,572.6 2,800.0 1,172.6 1,400.0 - 334.0 334.0 - 227.4 227.4 434.0 100.0 327.4 100.0 Computations: 1a (110/100) x $2,132 = $2,345.2 1b ½ x $2,132+ $1,400 = $2,466.0; x $1,400 = $2,800; ½x (110/100) x $2,132+ $1,400 = $2,572.6 1c ½ x $2,132= $1,066; ½x $2,800; (110/100) x $1,066.0 = $1,172.6 1d ½ x ($2,800 - $2,132) = $334.0; ½ x ($2,800 - $2,345.2) = $227.4 $1,500 - $1,066.0 = $434.0; $1,500 - $1,172.6 = $327.4; $1,500 $1,400 = $100 1018 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 17-51 (15-20 min.) The general price level increased, as shown by positive values under "effect of increase in general price level." Therefore, the asset values of all three firms would have to increase to keep pace with inflation, Gannett by $37.5 million, Zayre by $55.5 million, and Goodyear by $252.0 million The specific prices of Gannett's assets increased by $45.8 million, $8.3 million more than the rate of inflation Zayre's increased by $24.9 million, but this is less than the inflation rate by $30.6 million Goodyear's specific asset prices actually fell by $4.7 million, dropping them $256.7 million (in inflation-adjusted dollars) behind their beginning-of-the-year value 17-52 (15-25 min.) The fact that Nike’s financial statements are “consolidated” means that Nike combines the statements of the parent company with those of 50% to 100% owned subsidiaries Because Nike shows no “minority interest” on either the income statement or balance sheet, it must own 100% of all of its subsidiaries Sales among consolidated entities must be eliminated when forming consolidated statements Thus, the sales from Converse to the Nike retail stores must be eliminated That means that, after adding together the accounts of Nike and its subsidiaries, sales must be reduced by $10 million and cost of sales by $6 million in the income statement, reducing operating income by $4 million On the balance sheet, since income is $4 million less, retained earnings will also be $4 million less In addition, the $10 million initially shown on the balance sheet for Nike’s retail stores’ inventory must be reduced to Converse’s purchase price of $6 million, a $4 million decrease 1019 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Following are the interpretations of the changes in each of the ten ratios: a Current ratio – The decline is generally bad, reflecting less liquidity However, it might reflect better inventory control, possibly by using just-in-time methods, which could be good b Average collection period – A slight improvement c Debt to equity – The increase shows an increasing use of debt, which increases risk but may also mean that Nike is making better use of leverage d Gross profit rate – The decline, although not large, is not good news It reflects shrinking margins on sales e Return on sales – The increase is positive, showing that control of expenses other than cost of sales must have more than offset the decrease in gross profit f Return on stockholders’ equity – The increase is positive, although the amount of the increase is small g Earnings per share – The 16% increase in EPS is indeed good news The earnings attributable to each share of stock is significantly higher in 2006 than in 2005 h Price-earnings – The decline in the P-E ratio shows that investors have revised downward their predicted growth rate for Nike This is not a good sign However, it should also be compared with the change in the average P-E ratio for all stocks; it might be caused at least partly by overall stock market movements, not just by expectations for Nike i Dividend yield – The increase in dividend yield is positive for most investors It means that they are receiving a larger percentage of their investment back in the form of dividends j Dividend payout – The increasing dividend payout ratio can have mixed interpretations Although the change is small, an increase in payout means the shareholders get more assured return However, it can also mean that Nike has fewer investment opportunities for the cash it is generating 1020 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 17-53 (25-35 min.) For the solution, see the Prentice Hall Web site, www.prenhall.com/ 17-54 (60 or more) The purpose of this exercise is two-fold The first is to establish familiarity with four basic ratios The second is to deduce why these ratios might vary from company to company Computing the ratios will cause students to find and read a company’s annual financial statements They will become familiar with some aspects of that particular company as well as learning where in the financial statements to find the needed information Students’ reasoning skills will be developed when they come together as a group and try to determine reasons for differences in companies’ ratios Some of the conclusions they may draw are: a Earnings per share depend on the number of shares issued compared to the value of the company If one share costs nearly $110,000, as for Berkshire Hathaway class A shares, earnings per share will be much higher than for a share that costs $10 Earnings per share is also a good measure of the economic success of a company over the last year If earnings per share decline from one year to the next, it is likely that economic results were not favorable b The price-earnings ratio depends primarily on the growth prospects for a company’s earnings The greater the expected earnings growth, the greater the P-E ratio c, d Dividend yield is a measure of the amount of dividends a shareholder can expect per dollar invested Dividend payout ratio is the percentage of income paid out in dividends These two ratios are highly related Companies that have excellent internal investment opportunities for cash (often growing companies) will generally pay out a low percentage of their income and have a low dividend yield 1021 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 17-55 (30-40 min.) NOTE TO INSTRUCTOR This solution is based on the web site as it was in early 2007 when the 2006 annual report was the latest one available Be sure to examine the current web site before assigning this problem, as the information there may have changed General Electric labels its financial statements “General Electric Company and consolidated affiliates.” Therefore, the company must consolidate some subsidiaries into its statements On the income statement there is an account called “Minority interest in net earnings of consolidated affiliates,” so there must be some subsidiaries that are not 100% owned GE calls its balance sheet a “Statement of Financial Position.” GE does not have subtotals for current assets and current liabilities, although the current items are listed first under both assets and liabilities Its minority interest is $7,578 million This means that of the equity in the consolidated subsidiaries, GE owns all but $7,578 million That means that $7,578 million of the equity in the subsidiaries is held by outside shareholders The income statement shows cash dividends of $1.03 per share, out of net income of $2.01 per share (using basic earnings per share), for a payout ratio of $1.03 ÷ $2.01 = 51.2% GE’s return on stockholders’ equity for the last two years is: 2006: $20,829 ÷ (1/2 x ($112,314 + $109,351*)) = 18.8% 2005: $16,711 ÷ (1/2 x ($109,351 + $110,908*)) = 15.2% *From 2005 annual report All other numbers are in the 2006 annual report The return increased in 2006 from what it was in 2005, which is good for investors 1022 ... the Treasurer can pay out to investors all of the net income as measured by the traditional historical cost method That leaves the company an amount equal to the historical cost of the assets... available to pay to investors and still maintain physical capital 992 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Which measure an investor might... evidence showing that the stock market is not likely to be "fooled" by manipulating reported income Only an accounting change that discloses new information will affect stock prices 17-21 Return