Chapter 08 - Financial Statement Analysis

SOLUTIONS MANUAL CHAPTER 08 FINANCIAL STATEMENT ANALYSIS

Answers to Text Discussion uestions

!" Does a balance sheet that is dated year-end 2007 reflect only transactions for that year? 8#!" No. he balance sheet is a c!m!lati"e chronicle of all transactions that ha"e affected the corporation since its inception.

$" #$plain %hy the statement of cash flo%s is partic!larly rele"ant in li&ht of the fact that the accr!al method of acco!ntin& is !sed in the income statement and balance sheet. 8#$" 'eca!se of accr!al acco!ntin&( the income statement and balance sheet reco&ni)e re"en!e and e$penses as they occ!r rather than %hen cash chan&es hands. he statement of cash flo%s forces !s to e$amine the act!al cash position of the firm.

%" Can %e a!tomatically ass!me that a firm that has an operatin& loss on the income statement has red!ced the cash flo%s for the firm d!rin& the period? 8#%" No. here may be a lar&e non-cash depreciation %rite-off *or similar ded!ction+ d!rin& the period.

&" ,hat ratios are li-ely to be of &reatest interest to the ban-er or trade creditor? o the bondholder? 8#&" he ban-er or trade creditor %ill ta-e the hardest loo- at the li.!idity ratios to determine the firm/s c!rrent ability to meet short-term debt obli&ations. he bondholder may be primarily infl!enced by debt to total assets( %hile also eyein& the profitability of the firm in terms of its ability to co"er interest payments in the shortterm and principal payments in the lon&-term.

'" 0f a firm1s operatin& mar&in and after-ta$ mar&in are almost the same *an !n!s!al case+( %hat can %e say abo!t the firm? 8#'" ,e can infer that the firm has little or no interest payments *or that interest payments and interest income are the same+ and that income ta$es are .!ite small.

(" Comment on the hea"y capital &oods ind!stry and the food-processin& ind!stry in terms of performance !nder the D! 2ont system of analysis.

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Chapter 08 - Financial Statement Analysis

8#("

0n the hea"y capital &oods ind!stry( the emphasis is on a hi&h profit mar&in %ith a lo% asset t!rno"er( %hile in food processin& the profit mar&in is lo% and the -ey to satisfactory ret!rns on total assets is a rapid t!rno"er of assets. )" 0n comp!tin& ret!rn on assets( ho% does the a&e of the assets infl!ence the interpretation of the "al!es? 8#)" 4ld assets %ill be carried on the boo-s at a lo% depreciated "al!e %hich %ill tend to ma-e the ret!rn fi&!res appear hi&h. his is in contrast to ratios based on ne%ly p!rchased e.!ipment. he analyst may %ish to partially disco!nt the appearance of hi&h rates of ret!rn on older assets. An e"en better approach %o!ld be to !se replacement cost acco!ntin&.

8" 0f a firm1s ret!rn on e.!ity is s!bstantially hi&her than the firm1s ret!rn on assets( %hat can the analyst infer abo!t the firm? 8#8" he firm has a hea"y debt commitment. his can be seen by loo-in& at the D!2ont System and the relationship bet%een debt( ret!rn on assets and ret!rn on e.!ity.

*" 5o% do the asset-!tili)ation ratios relate to the li.!idity ratios? 8#*" he faster t!rno"er of assets creates a more rapid mo"ement of cash thro!&h the company and impro"es li.!idity *and th!s the li.!idity ratios+.

!0" Can p!blic !tility firms better 6!stify the !se of hi&h debt than firms in the a!tomobile or airline ind!stry? Comment7 8#!0" 'eca!se p!blic !tility firms ha"e more stable sales and earnin&s( they can afford to employ more le"era&e than firms in cyclical ind!stries s!ch as a!tomobiles and airlines. !!" ,hy %ill the fi$ed-char&e-co"era&e ratio al%ays be e.!al to or less than times interest earned? 8#!!" 'eca!se the fi$ed char&e co"era&e ratio co"ers all types of fi$ed char&es and not 6!st interest. 8ease payments and sin-in& f!nd obli&ations may represent important forms of fi$ed char&es. 0f the only fi$ed char&e is interest e$pense( then the fi$ed char&e co"era&e ratio %ill e.!al the times interest earned ratio. !$" ,hat mi&ht a hi&h di"idend-payo!t ratio s!&&est to an analyst abo!t a company1s &ro%th prospects? 8#!$" A hi&h payo!t ratio tells the analyst that the stoc-holder is recei"in& a lar&e part of the earnin&s( and that the company is not retainin& m!ch income for ne% plant and e.!ipment. 5i&h payo!t ratios are !s!ally fo!nd in companies that do not ha"e &reat &ro%th potential.

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Chapter 08 - Financial Statement Analysis

!%" #$plain the probable impact of replacement-cost acco!ntin& on the ratios of ret!rn on assets( debt to total assets( and times interest earned for a firm that has s!bstantial old fi$ed assets. 8#!%" 9et!rn on assets:9eplacement cost acco!ntin& decreases income( b!t increases assets( so ret!rn on assets %ill &o do%n. Debt to total assets:Debt remains the same( b!t asset "al!es &o !p( so debt to total assets %ill &o do%n. PRO+LEMS Inco,e st-te,ent !" Sin&!lar Corp. has the follo%in& income statement data; Sales ?ross profit Sellin& and administrati"e e$pense 0nterest e$pense Net income *after these and other e$penses+ 200< =>00(000 3<3(@00 A>(200 3>(200 AA(300 2007 =700(000 20>(000 7A(@00 2B(300 A>(<00

a. Comp!te the ratio of each of the last fo!r items to sales for 200< and 2007. b. 'ased on yo!r calc!lations( is the company impro"in& or declinin& in its performance? 8#!" a+ Sin.u/-r Cor0" $00( ?ross profitCSales Sellin& and administrati"e e$penseCSales 0nterest e$penseCSales Net incomeCSales b+ @2.2<D B.0AD @.0AD 8.82D $00) 2B.2BD 30.<3D A.3<D <.>3D

he company is not performin& as %ell in 2007 as it did in 200<. he E&ross profit mar&inF has &one do%nG Esellin& and administrati"e e$penseF as %ell as Einterest e$penses as a percent of salesF has &one !p. As %o!ld be e$pected based on the abo"e( net income to sales ha"e &one do%n.

+-/-nce s1eet $" A company has =200(000 in in"entory( %hich represents 20 percent of c!rrent assets. C!rrent assets represent >0 percent of total assets. otal debt represents @0 percent of total assets. ,hat is stoc-holders1 e.!ity?

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Chapter 08 - Financial Statement Analysis

8#$" 0n"entory of =200(000 is 20D of c!rrent assets. his means c!rrent assets are $1,000,000. C!rrent assets of =3(000(000 are >0 percent of total assets. his means total assets are $2,000,000. otal debt represents @0 percent of total assets. his means total debt is $600,000. he balance of total assets m!st be financed %ith stoc-holders1 e.!ity. his means stoc-holders1 e.!ity is $1,400,000. otal assets H total debt I Stoc-holders1 e.!ity =2(000(000 H =<00(000 I =3(A00(000 Du Pont -n-/2sis %" ?i"en the follo%in& financial data; Net incomeCSales I A percentG SalesC otal assets I @.> timesG DebtC otal assets I <0 percentG comp!te; a. 9et!rn on assets. b. 9et!rn on e.!ity. 8#%" a+ 9et!rn on assets = Net 0ncome Sales Sales otal assets

3AD =AD @.>

b+ 9et!rn on e.!ity =

9et!rn on Assets *3 Debt C otal assets+ 3AD *3 .<0+

@>D =

Du Pont -n-/2sis &" #$plain %hy in problem @ ret!rn on e.!ity %as so m!ch hi&her than ret!rn on assets. 8#&" 9et!rn on e.!ity %as so m!ch hi&her than ret!rn on assets beca!se the firm had hea"y debt in its capital str!ct!re. *<0 percent of assets+. his means that the firm has a relati"ely small e.!ity base a&ainst %hich to &enerate income %hich leads to a hi&her ret!rn on e.!ity.

Du Pont -n-/2sis '" A firm has assets of =3(800(000 and t!rns o"er its assets 2.> times per year. 9et!rn on assets is 20 percent. ,hat is its profit mar&in *ret!rn on sales+?

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Chapter 08 - Financial Statement Analysis

Net 0ncome 8#'"

= otal Assets 9et!rn on Assets = =3(800( 000 20D = =@<0( 000 = otal Assets Sales C otal Assets = =3(800( 000 2.> = =A(>00( 000 = =@<0( 000 C =A(>00( 000 = 8D

Sales

Net 0ncome C Sales

Du Pont -n-/2sis (" A firm has assets of =3(800(000 and t!rns o"er its assets 3.> times per year. 9et!rn on assets is 2> percent. ,hat is its profit mar&in *ret!rn on sales+? Net 0ncome 8#(" = otal Assets 9et!rn on Assets = =3(800( 000 2>D = =A>0( 000 = otal Assets Sales C otal Assets = =3(800( 000 3.> = =2( 700( 000 = =A>0( 000 C =2( 700( 000 =3<.<7D

Sales

Net 0ncome C Sales *2rofit Jar&in+

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Chapter 08 - Financial Statement Analysis

Du Pont -n-/2sis )" A firm has a ret!rn on assets of 32 percent and a ret!rn on e.!ity of 38 percent. ,hat is the debt-to-total assets ratio? 8#)" 9et!rn on e.!ity = 9et!rn on Assets *3 Debt C otal assets+ 32D *3 K+

38D =

38D *3 K+ =32D 38D 38DK = 32D 38DK = <D K = @@D he debtCtotal assets ratio is @@D. 2roof 9et!rn on e.!ity = 32D 32D = = 38D *3 @@+ .<7

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Chapter 08 - Financial Statement Analysis

Du Pont -n-/2sis 8" 0n the year 2007( the a"era&e firm in the SL2 >00 0nde$ had a total mar-et "al!e of fi"es times stoc-holders1 e.!ity *boo- "al!e+. Ass!me a firm had total assets of =30 million( total debt of =< million( and net income of =<00(000. a. ,hat is the percent ret!rn on e.!ity? b. ,hat is the percent ret!rn on total mar-et "al!e? Does this appear to be an ade.!ate ret!rn on the act!al mar-et "al!e of the firm? 8#8" a+ 9et!rn on e.!ity = otal assets otal debt Stoc-holders /e.!ity or 9et!rn on e.!ity = 9et!rn on Assets *3 Debt C otal Assets+ =<00( 000 C =30( 000( 000 = *3 .<0+ Net 0ncome =<00( 000 =3>D Stoc-holders / #.!ity =A( 000( 000 =30( 000( 000 <( 000( 000 A( 000( 000

<D =3>D .A0 Net 0ncome otal Jar-et Mal!e b+ otal Jar-et Mal!e = Stoc-holders / #.!ity > =20( 000( 000 = =A( 000( 000 > =<00( 000 9et!rn on mar-et "al!e = = @D =20( 000( 000 9et!rn on Jar-et Mal!e = he ret!rn on total mar-et "al!e of three percent appears to the small( partic!larly %hen in"estors can &et a hi&her rate on certificates of deposit *CDs+. he intend of this problem is to sho% it is not only ret!rn on stoc-holders1 e.!ity that is important( b!t also %hat the firm can earn on its total "al!e in the mar-et. 0t is the latter term that represents the tr!e "al!e of the firm to stoc-holders.

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Chapter 08 - Financial Statement Analysis

3ener-/ r-tio -n-/2sis *" A firm has the follo%in& financial data; C!rrent assets =<00(000 Fi$ed assets A00(000 C!rrent liabilities @00(000 0n"entory 200(000 0f in"entory increases by =300(000( %hat %ill be the impact on the c!rrent ratio( the .!icratio( and the net-%or-in&-capital-to-total-assets ratio? Sho% the ratios before and after the chan&es. 8#*" 'efore After =<00( 000 = 2K =@00( 000 =A00( 000 = 3.@@K =@00( 000 =<00( 000 =@00( 000 =<00( 000 + =A00( 000 =700( 000 = 2.@@K =@00( 000 =A00( 000 = 3.@@K =@00( 000 =700( 000 =@00( 000 700( 000 + =A00( 000

C!rrent ratio

N!ic- ratio Net %or-in& capital to total assets

=@00( 000 = @0D =3( 000( 000

=A00( 000 = @<.@<D =3(300( 000

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Chapter 08 - Financial Statement Analysis

3ener-/ r-tio -n-/2sis !0" ?i"en the follo%in& financial data( comp!te; a. 9et!rn on e.!ity. b. N!ic- ratio. c. 8on&-term debt to e.!ity. d. Fi$ed-char&e co"era&e. Assets; Cash............................................................................................ Acco!nts recei"able................................................................... 0n"entory.................................................................................... Fi$ed assets................................................................................ otal assets....................................................................................... 8iabilities and stoc-holders1 e.!ity; Short-term debt.......................................................................... 8on&-term debt........................................................................... Stoc-holders1 e.!ity.................................................................. otal liabilities and stoc-holders1 e.!ity......................................... 0ncome before fi$ed char&es and ta$es............................................ 0nterest payments............................................................................. 8ease payment................................................................................. a$es *@> percent ta$ rate+............................................................... Net income *after-ta$es+.................................................................. Net income =2( 080 = = 3@.87D Stoc-holders /e.!ity =3>( 000 Cash + Acco!nts recei"able =>(>00 = = 3.8@K Short term debt @( 000 8on& term debt =2( 000 = = 3@.@@D Stoc-holders /e.!ity 3>( 000 = 2(>00 @(000 <(>00 8(000 =20(000

= @(000 2(000 3>(000 =20(000 = A(A00 800 A00 3(320 = 2(080

8#!0" a+

b+

c+

0ncome before fi$ed char&es L ta$es =A( A00 = 0nterest payment + 8ease payment =800 + =A00 d+ =A( A00 = = @.<7K =3( 200

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Chapter 08 - Financial Statement Analysis

Co4er-.e o5 sin6in. 5un7 !!" Ass!me in part d of problem 30 that the firm had a sin-in& f!nd payment obli&ation of =200. 5o% m!ch before-ta$ income is re.!ired to co"er the sin-in&-f!nd obli&ation? ,o!ld lo%er ta$ rates increase or decrease the before-ta$ income re.!ired to co"er the sin-in& f!nd? 'efore-ta$ income re.!ired I After - ta$ payment *3 a$ rate+ =200 = *3 .@>+ =200 = .<> = =@07.<B

8#!!"

8o%er ta$ rates %o!ld decrease the amo!nt of before-ta$ income re.!ired to co"er the sin-in& f!nd. As an e$ample( red!ce the ta$ rate to 20 percent and recomp!ted the ans%er. =200 C*3 0.2+ = =200 C 0.8 = =2>0 Return on e8uit2 !$" 0n problem 30( if total debt %ere increased to >0 percent of assets and interest payments %ent !p by =@00( %hat %o!ld be the ne% "al!e for ret!rn on e.!ity? 0ncome before fi$ed char&es and ta$es 0nterest payments *=800 + =@00+ 8ease payments a$es *@>D ta$ rate+ Net 0ncome *after ta$es+ =A( A00 3(300 A00 3( 03> =3(88>

8#!$"

Ne% stoc-holders /e.!ity = .>0 =20( 000 = =30( 000 Net income =3(88> = = 38.8>D Stoc-holders /e.!ity =30( 000

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Chapter 08 - Financial Statement Analysis

Stoc6 0rice r-tios !%" Ass!me the follo%in& financial data; Short-term assets.............................................................................. 8on&-term assets.............................................................................. otal assets................................................................................. Short-term debt................................................................................. 8on&-term debt................................................................................. otal liabilities........................................................................... Common stoc-................................................................................. 9etained earnin&s............................................................................. otal stoc-holders1 e.!ity.......................................................... otal liabilities and stoc-holders1 e.!ity......................................... otal earnin&s *after-ta$+.................................................................. Di"idends per share.......................................................................... Stoc- price........................................................................................ Shares o!tstandin&...........................................................................

=@00(000 >00(000 =800(000 =200(000 3<8(000 @<8(000 200(000 2@2(000 A@2(000 =800(000 = 72(000 = 3.AA = A> 2A(000

a. Comp!te the 2C# ratio *stoc- price to earnin&s per share+. b. Comp!te the boo- "al!e per share *note that boo- "al!e e.!als stoc-holders1 e.!ity+. c. Comp!te the ratio of stoc- price to boo- "al!e per share. d. Comp!te the di"idend yield. e. Comp!te the payo!t ratio. a+ 2 C # ratio 8#!%" 2r ice #2S #arnin&s =72( 000 #2S = = = =@ Shares 2A( 000 =A> 2C# = =3>K =@ = Stoc-holders /e.!ity Shares =A@2( 000 2A( 000

b+ 'oo- "al!e per share =

= =38

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Chapter 08 - Financial Statement Analysis

c+Stoc- price to boo- "al!e = d+ Di"idend yield =

=A> = 2.>K =38

Di"idends per share Common stoc- price =3.AA = = @.2D =A>

e+ 2ayo!t ratio =

Di"idends per share #arnin&s per share =3.AA = = A8D =@.00

T-x consi7er-tions -n7 5in-nci-/ -n-/2sis !&" 9eferrin& to problem 3@; a. Comp!te after-ta$ ret!rn on e.!ity. b. 0f the ta$ rate %ere A0 percent( %hat co!ld yo! infer the "al!e of before-ta$ income %as? c. No% ass!me the same before-ta$ income comp!ted in part b( b!t a ta$ rate of 2> percentG recomp!te after-ta$ ret!rn on e.!ity *!sin& the simplifyin& ass!mption that e.!ity remains constant+. d. Ass!me the ta$es in part c %ere red!ced lar&ely as a res!lt of one-time nonrec!rrin& ta$ credits. ,o!ld yo! e$pect the stoc- "al!e to &o !p s!bstantially as a res!lt of the hi&her ret!rn on e.!ity? 8#!&" a+ Net income =72( 000 = = 3<.<7D Stoc-holders /e.!ity =A@2( 000 After - ta$ income *3 a$ rate+ =72( 000 = *3 .A0+ = =320( 000 320( 000 @0( 000 =B0( 000

b+ 'efore - ta$ income =

c+ 'efore - ta$ income a$es *2>D+ After - ta$ income

Net income =B0( 000 = = 20.8@D Stoc-holders /e.!ity A@2( 000

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Chapter 08 - Financial Statement Analysis

d+ No. Since the increased ret!rn on stoc-holders1 e.!ity is a one time e"ent( stoc-holders %ill not forecast a permanently hi&her income stream and increase "al!ation s!bstantially. Di4ision-/ -n-/2sis !'" he J!lti-Corporation has three different operatin& di"isions. Financial information for each is as follo%s; Clothin& Appliances Sportin& ?oods Sales.............................................. =@(000(000 =3>(000(000 =2>(000(000 4peratin& income.......................... @@0(000 3(2>0(000 @(200(000 Net income *AC +.......................... 3@>(000 870(000 3(A00(000 Assets............................................ 3(200(000 30(000(000 8(000(000 a. ,hich di"ision pro"ides the hi&hest operatin& mar&in? b. ,hich di"ision pro"ides the lo%est after-ta$ profit mar&in? c. ,hich di"ision has the lo%est after-ta$ ret!rn on assets? d. Comp!te net income *after-ta$+ to sales for the entire corporation. e. Comp!te net income *after-ta$+ to assets for the entire corporation. f. he "ice president of finance s!&&ests the assets in the Appliances di"ision be sold off for =30 millions and redeployed in Sportin& ?oods. he ne% =30 million in Sportin& ?oods %ill prod!ce the same after-ta$ ret!rn on assets as the c!rrent =8 million in that di"ision. 9ecomp!te net income to total assets for the entire corporation ass!min& the abo"e s!&&ested chan&e. g. #$plain %hy Sportin& ?oods( %hich has a lo%er ret!rn on sales than Appliances( has s!ch a positi"e effect on ret!rn on assets. 8#!'" Clothin& a+ 4peratin& incomeCsales b+ Net incomeCsales c+ Net incomeCassets Net income Sales *for corporation+ 33.00D A.>0D 33.2>D Appliances 8.@@D >.80D 8.70D Sportin& ?oods 32.8D >.<D 37.>D

d+

*All "al!es in 0001s+

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Chapter 08 - Financial Statement Analysis

otal net income =3@> + 870 + 3( A00 = otalsales =@( 000 + 3>( 000 + 2>( 000 =2( A0> = = >.>BD =A@( 000 Net income otal assets *for corporation+ *All "al!es in 000/s+ e+ otal net income =3@> + 870 + 3( A00 = otal assets =3( 200 + 30( 000 + 8( 000 =2( A0> = = 32.>@D =3B( 200

f+ =30(000(000 from Appliances is redeployed in Sportin& ?oods at an after-ta$ ret!rn on assets of 37.> percent. his %ill mean incremental afterta$ income of =3(7>0(000 for Sportin& ?oods to replace the =870(000 from Appliances. otal after-ta$ income %ill increase by =880(000 to =@(28>(000. Net income to total assets for the corporation %ill no% be; otal net income =@( 28>( 000 = = 37.33D otal assets =3B( 200( 000 &+ he bi& ad"anta&e that Sportin& ?oods has o"er Appliances is a rapid t!rno"er of assets( %hich leads to a hi&h ret!rn on assets despite a relati"ely lo% ret!rn on sales. he asset t!rno"er ratio for the Sportin& ?oods di"ision is @.32>( b!t only 3.> for Appliances. A00ro-c1es to securit2 e4-/u-tion !(" Sec!rity Analyst A thin-s the Collins Corporation is %orth 3A times c!rrent earnin&s. Sec!rity Analyst ' has a different approach. 5e ass!mes that A> percent of earnin&s *per share+ %ill be paid o!t in di"idends and the stoc- sho!ld pro"ide a A percent c!rrent di"idend yield. Ass!me total earnin&s are =32 million and that > million shares are o!tstandin&. a. Comp!te the "al!e of the stoc- based on Sec!rity Analyst A1s approach. b. Comp!te the "al!e of the stoc- based on Sec!rity Analyst '1s approach. c. Sec!rity Analyst C !ses the constant di"idend "al!ation model approach presented in Chapter 7 as Form!la 7O> on pa&e 3A7. She !ses Sec!rity Analyst '1s ass!mption abo!t di"idends *per share+ and assi&ns a &ro%th rate( g( of B percent and a re.!ired rate of ret!rn *Ke+ of 32 percent. 0s her "al!e hi&her or lo%er than that of the other sec!rity analysts?

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Chapter 08 - Financial Statement Analysis

8#!("

a+Sec!rity Analyst A 2r ice = 2 C # #2S =32( 000( 000 #2S = = =2.A0 >( 000( 000 2r ice = 3A =2.A0 = =@@.<0 b+Sec!rity Analyst ' Di"idend per share 2r ice = .0A Di"idend per share = .A> =2.A0 = =3.08 =3.08 2r ice = = =27 .0A c+ 2o = D3 = =3.08 C*.32 .0B+ = =@< *P e &+

0t is hi&her. Co,9inin. Du Pont -n-/2sis wit1 P:E r-tios !)" Sarah 'ailey is analy)in& t%o stoc-s in the semicond!ctor ind!stry. 0t is her intention to assi&n a 2C# of 3< to the a"era&e firm in the ind!stry. 5o%e"er( she %ill assi&n a 20 percent premi!m to the 2C# of a company that !ses conser"ati"e financin& in its capital str!ct!re. his is beca!se of the hi&hly cyclical nat!re of the ind!stry. %o firms in the ind!stry ha"e the follo%in& financial data; 2alo Alto Semicond!ctors '!rr 9id&e Semicond!ctors Net incomeCSales >.0D A.2D SalesC otal assets 2.3 @.> DebtC otal assets <0D @0D #arnin&s =A0 million =3> million Shares =3< million =<.2> million a. Comp!te ret!rn on stoc-holders1 e.!ity for each firm. Qse the D! 2ont Jethod of analysis. ,hich is hi&her? b. Comp!te earnin&s per share for each company. ,hich is hi&her? c. Applyin& the 20 percent premi!m to the 2C# ratio of the firm %ith the more conser"ati"e financial str!ct!re and the ind!stry 2C# ratio of the other firm( %hich firm has the hi&her stocprice "al!ation? 8#!)" a+ Net incomeCSales SalesCtotal assets 9et!rn on assets P-/o A/to Se,icon7uctors >.0D 2.3 30.>D
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+urr Ri7.e Se,icon7uctors A.2D @.> 3A.7D

Chapter 08 - Financial Statement Analysis

DebtCtotal assets

<0.0D

@0.0D

9et!rn on stoc-holders /e.!ity

30.>D 3A.7D = 2<.>2D = 23.00D *3-<0+ *3-.@0+

2alo Alto Semicond!ctors is hi&her *2<.>2D "s. 23.00D+. b+ #2S = #arnin&s Shares P-/o A/to A0 million = =2.>0 3< million +urr Ri7.e =3> million = =2.A0 <.2> million

2alo Alto Semicond!ctors is hi&her *=2.>0 "s. =2.A0+. c+ '!rr 9id&e is more conser"ati"e %ith a debt ratio of @0D "s. <0D for 2alo Alto. 2.>0 2.A0 3< 3B.2R =A0.00 =A<.08 R3<$ + 20D premi!m =3B.2$ '!rr 9id&e Semicond!ctors is hi&her *=A<.08 "s. =A0.00+. Stoc- #2S = 2r ice 2 C # 9atio

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Chapter 08 - Financial Statement Analysis

Critic-/ T1ou.1t C-se ; Focus on Et1ics 'arry Jin-o% fo!nded SSSS 'est Co.( a carpet-cleanin& firm( %hen he %as 3> years ld. 5e ran the b!siness from his family1s &ara&e in 9eseda( California. he company became one of the bi&&est carpet-cleanin& firms in California( and Jin-o% %as a millionaire by a&e 38. Jin-o% too- his company p!blic by sellin& its stoc- %hen he %as 23( and his personal %orth %as estimated at close to =30 million. At that time SSSS 'est *ESee 'estF+ had 3(@00 employees and 2000 sales of =A.8 million. Jin-o% boldly predicted that 200A re"en!es %o!ld e$ceed =>0 million. 0n T!ly 2007( SSSS 'est mana&ement filed for ban-r!ptcy protection and s!ed Jin-o% for misappropriatin& =23 million in company f!nds. 0n addition( se"eral c!stomers acc!sed SSSS 'est of o"erchar&in& them in a credit card scam. Jin-o% p!blicly admitted the o"erchar&es b!t blamed them on s!bcontractors and employees. 5e also said he had fired those responsible and had personally repaid the char&es. he Sec!rities and #$chan&e Commission *S#C+ and other la% enforcement a&encies be&an in"esti&atin& Jin-o% and his company. 0t became apparent that SSSS 'est %as b!ilt on a fo!ndation of lies( dishonesty( and inconsistent acco!ntin& practices. he company had s!bmitted phony credit card char&es and had iss!ed press releases claimin& millions of dollars in bo&!s contracts( sendin& the price of the company1s stoc- e"en hi&her. he S#C in"esti&ated other char&es( incl!din& possible phony recei"ables( bo&!s financial acco!ntin& statements( or&ani)ed crime connections( and sec!rities la% "iolations by Jin-o% and other e$ec!ti"es. he S#C placed an independent tr!stee in char&e of the company !ntil its acco!ntin& records co!ld be e$amined. he 8os An&eles 2olice Department in"esti&ated char&es that SSSS 'est %as a money-la!nderin& operation for or&ani)ed crime. he in"esti&ation lin-ed Jin-o% and SSSS 'est %ith dr!& dealin&s and or&ani)ed crime members. hese alle&ations !ltimately led Jin-o% to resi&n from SSSS 'est for Ehealth reasons.F '!t his resi&nation %as not the end of his tro!bles. SSSS 'est1s ne% mana&ement s!ed Jin-o% for embe))lin& =@ million of the company1s f!nds for his personal !se and misappropriatin& =38 million to perform fictitio!s ins!rance restoration %or-. he s!it char&ed that Jin-o% act!ally di"erted this money to an associate1s ref!rbishin& b!siness( %hich %as part of an elaborate scheme desi&ned to allo% Jin-o% to ta-e corporate f!nds for his o%n and others1 personal !se. Accordin& to the s!it( these discrepancies in the company1s acco!ntin& practices %ere the reasons behind the ban-r!ptcy filin&. As a res!lt SSSS 'est1s acco!ntin& firm .!it.

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Chapter 08 - Financial Statement Analysis

uestions !" 3i4en t1e extent o5 5r-u7 in t1is c-se< s1ou/7 ==== +est>s -ccountin. 5ir, 9e 1e/7 res0onsi9/e 5or not 7isco4erin. t1e 5r-u7u/ent -cti4ities? Fra!d!lent acti"ities %ithin a company are often .!ite diffic!lt to detect. A!ditors claim that any %ell-laid plan of fra!d!lent acti"ities can decei"e e"en the best C2As. 0n the past the a!ditin& profession operated !nder the ass!mption that it %as responsible for detectin& anythin& that materially chan&es the financial statements. he chan&es co!ld come from a n!mber of places s!ch as errors in pricin& in"entory( the mis!se of acco!ntin& practices( and misinterpretation of financial data. Fra!d is 6!st one of the many thin&s to be considered. A!dits &enerally are not planned aro!nd the premise that ille&al acti"ities ha"e occ!rred. '!t( that does not mean the a!ditor is not responsible for detectin& s!ch acti"ities that si&nificantly chan&e the financial statements. So( sho!ld they be held acco!ntable? he S#C did not thin- so. $" @1-t -re t1e res0onsi9i/ities o5 t1e 9ro6er -n7 5in-nci-/ -n-/2st in reco,,en7in. t1e co,0-n2 to in4estors? To w1-t extent -re t1e2 res0onsi9/e 5or t1eir in4est,ent reco,,en7-tions? A bro-er1s recommendation to p!rchase a partic!lar stoc- is !s!ally based on the opinion of his in-ho!se financial analyst( and( if the bro-er had recommended SSSS 'est as a &ood stoc- p!rchase( he really did not do anythin& ethically %ron&. No% if the bro-er -ne% of the shenani&ans &oin& on at the company( then he most definitely %o!ld be in the %ron&. he same is relati"ely tr!e for the financial analyst( b!t %hat abo!t the fact that analysts often ha"e access to many of the same pieces of information as a!ditors? ,o!ld it be ethically %ron& for the financial analyst to recommend the stoc- e"en if he mis6!d&ed the company? 2robably not beca!se e"en tho!&h analysts do ha"e access to some of the same records( a!ditors ha"e access to information that is not al%ays a"ailable to the p!blic. he financial analyst co!ld not be acc!sed of ethical miscond!ct if he -no%in&ly recommended the stoc- after learnin& abo!t the .!estionable acti"ities of the company.

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