PROBLEM 12-3.

Return on Investment [LO 2] Consider the following information for

McKinley and Son:

12/31/2017 12/31/2018

Total assets 55,000,000 62,000,000

Noninterest-bearing 1,100,000 1,320,000

current liabilities

Net income 3,300,000 3,426,000

Interest Expense 726,000 770,000

Tax rate 35% 35%

a. Evaluate the company in terms of ROI.

Amount in $ 2017 Amount in $ 2018

Net Income 3,300,000 3,426,000
+ Tax 35% 1,776,923 1,844,769
Income before tax 5,076,923 5,720,769
+Interest 726,000 770,000
5,802,923 6,040,769
Less: Tax 35% 2,032,023 2,114,269
NOPAT 3,771,900 3,926,500

Investment capital:
Amount in $ 2017 Amount in $ 2018
Assets 55,000,000 62,000,000
Less: Liability 1,100,000 1,320,000
Invested capital 53,900,000 60,680,000

2017
NOPAT/Invested Capital = 3,771,900/53,900,000 = 0.06997 or 7%

2018
NOPAT/Invested Capital = 3,926,500/60,680,000 = 0.06471 or 6.47%

b. While income has increased in fiscal 2018, is it clear that the company’s
performance has improved?

The income and the capital investment of the company has increased but the ROI has
decreased. It shows that the company is not earning the return it was earning in 2017.
PROBLEM 12-7. ROI and EVA [LO 2, 3] ELN Waste Management has a subsidiary
that disposes of hazardous waste and a subsidiary that collects and disposes of
residential garbage. Information related to the two subsidiaries follows:

Hazardous Waste Residential Waste

Total assets 15,300,000 87,000,000
Noninterest- bearing 3,300,000 13,200,000
current liabilities
Net Income 1,870,000 6,600,000
Interest Expense 1,375,000 8,030,000
Required rate of return 10% 13%
Tax rate 40% 40%

Required
a. Calculate ROI for both subsidiaries.
Amount in $ Hazardous Waste Amount in $ Residential Waste
Net Income 1,870,000 6,600,000
+Tax 40% 1,246,667 5,500,000
Income before tax 3,116,667 1,100,000
Interest 1,357,000 8,030,000
4,491,667 9,130,000
Less: Tax 40% 1,796,667 3,652,000
NOPAT 2,695,000 5,478,000

Investment capital
Amount in $ Hazardous Waste Amount in $ Residential Waste
Assets 15,300,000 87,000,000
Less: Liability 3,300,000 13,200,000
Invested capital 12,000,000 73,800,000

NOPAT/Invested capital
Hazardous Waste = 2,695,000*100=12,000,000 or ~22.5%
Residential waste = 5,478,000*100=73,800,000 or ~7.47%

b. Calculate EVA for both subsidiaries. Note that since no adjustments for
accounting distortions are being made, EVA is equivalent to residual income.

Residential Income = NOPAT – [(cost of capital)(assets-non-interest bearing)]

2,695,000-[(.1)(15,300,000-3,300,000)]
2,695,000 – 1,200,000
1,495,000 for Hazardous waste

11,418,000-[(.13)(87,000,000-13,200,000)]
11,418,000 – 9,594,000
1,824,000 for Residential waste
c. Which subsidiary has added the most to shareholder value in the last year?

Hazardous waste subsidiary has a higher residual income resulting in a greater value to
shareholders

d. Based on the limited information, which subsidiary is the best candidate for
expansion? Explain.

Based on the information we have its recommended to expand hazardous waste

subsidiary because its return is the highest and the economic value added is positive as
well.

PROBLEM 12-10. Economic Value Added and the Balanced Scorecard [LO 2, 3]
The Spectrum Book Company has two divisions: The Brick and Mortar division sells
books through more than 100 bookstores throughout the United States; the Internet
division was formed 18 months ago and sells books via the Internet. Data for the past
year are:
Brick and Mortar Division Internet Division
Total assets 162,000,000 15,480,000
Noninterest- bearing 7,020,000 2,520,000
current liabilities
Interest Expense 1,260,000 418,500
Net Income (loss) 27,810,000 (1,125,000)
Tax rate 40% -0-
Cost of capital 10% 12%

Required
a. Evaluate the two divisions in terms of economic value added (EVA).

Brick and Mortar Division Internet Division

Net Income 27,810,000 (1,125,000)
+Tax 40% 18,540,000 -
Income before tax 46,350,000 (1,125,000)
+Interest 1,260,000 418,500
Less: Tax 40% 19,044,000 -
NOPAT 28,566,000 (706,500)

Invested Capital:
Brick and Mortar Division Internet Division
Assets 162,000,000 15,480,000
Less: Liability 7,020,000 2,520,000
Invested Capital 154,980,000 12,960,000

EVA (Brick and Mortar Division) = 28,566,000 – (.10*$154,980,000) = $13,068,000

EVA (Internet Division) = -706,500 – (0.12*$12,960,000) = $(2,261,700)
b. Explain why it might be better to evaluate the Internet division in terms of a
balanced scorecard rather than just using EVA.

Since the internet division has a negative NOPAT and EVA its better to evaluate it with
scored card.

c. Consider the customer and internal processes dimensions of the balanced

scorecard. Suggest two measures for each dimension that would be appropriate
for the Brick and Mortar division and two measures for each dimension that
would be appropriate for the Internet division.

Brick and Mortar Division

Customer Process
- More simplified way to find a book
- Efficient shipment service
Internal Process
- Reduce shipping inaccuracies
- Restructure ordering for more efficient pricing and costs for shipping

Internet Division
Customer process
- User friendly website
- more ads
Internal Process
- Easy access for customers to b download the book from their phones, tablets, laptops
etc.
- Quick dispatch from order to shipping.

d. A strategy map diagrams the relationship across the dimensions of the

balanced scorecard. Identify the potential links between the customer and
internal processes dimensions you identified in part c.

Please refer to C

PROBLEM 12-15. (Appendix) Decentralization and Transfer Pricing [LO A1] The
City of Medina Park operates a plumbing and electrical maintenance department,
responsible for maintaining all water and electric service functions in buildings owned by
the city. The city administration is concerned about the rising costs of the maintenance
department, which is currently organized as a cost center. Charlotte Daugherty, the
manager of the maintenance department, says that many of the department’s service
calls are strictly nuisance calls. She cites examples of numerous calls for defective
electrical outlets, which turn out to be unplugged equipment, burned-out light bulbs
(which can easily be changed by the users), and drains clogged by coffee grounds. In
Charlotte’s opinion, these nuisance calls would be avoided if the departments using her
department’s services were “billed.” Essentially, Charlotte suggests that there be a
transfer price related to using her department’s services and that the price should
approximate the cost of these services in the market ($50–$65 per hour of service time).
This would turn her operation into a profit center, and, she believes, her department
would operate more efficiently because demand for services would decline and she
would need fewer employees.

Required
Evaluate Charlotte’s proposal. Do you support use of a transfer price for
maintenance services? If so, should the price approximate the market price of
service or should it be based on cost?

Charlotte’s proposal is acceptable. By implementing the transfer fee and billing those
services rendered, Charlotte can minimize her workload and also reduce some of her
fixed costs.

Problem 14-13. Common-size financial statements [LO1] The financial statements

for the Bao Corporation are given below:

Bao Corporation Comparative Balance Sheets December 31,2018, and 2017

2018 2017
Assets
Current assets:
Cash 1,900 1.300
Accounts receivable, net 9,100 7,300
Inventory 11,300 9,100
Prepaid expenses 560 250
Total current assets 22,860 17,950
Property and equipment:
Land 86,000 86,000
Buildings and equipment, 48,600 52,000
net
Total property and 134,600 138,000
equipment
Total assets 157,460 155,950
Liabilities and
stockholders’ Equity
Current Liabilities
Accounts payable 17,600 21,000
Accrued expenses 1,620 4,430
Notes payable, short term 540 220
Total current liabilities 19,760 25,650
Long-term liabilities
Bonds payable 5,300 5,300
Notes payable 34,400 35,000
Total Liabilities 59,460 65,950
Stockholders’ equity
Common stock 11,000 11,000
Additional paid-in capital 19,000 19,000
Total paid-in capital 30,000 30,000
Retained earnings 68,000 60,000
Total stockholders’ equity 98,000 90,000
Total liabilities and 157,460 155,950
stockholders’ equity

Bao Corporation Comparative Balance Sheets December 31,2018, and 2017

2018 2017
Sales 130,000 111,000
Cost of goods sold 67,000 61,000
Gross margin 63,000 50,000
Operating expenses:
Selling expenses 24,500 20,000
Administrative expenses 17,500 14,600
Total operating expenses 42,000 34,600
Income from operations 21,000 15,400
Interest expense 5,600 4,700
Income before taxes 15,400 10,700
Less income taxes 6,160 4,280
Net income 9,240 6,240

Required

a. Present the balance sheet with each account balance as a percent of total
assets.
Bao Corporation Comparative Balance Sheets December 31,2018, and 2017
2018 2017
Assets
Current assets:
Cash 1,900 1.21% 1.300 0.83%
Accounts 9,100 5.78% 7,300 4.68%
receivable, net
Inventory 11,300 7.18% 9,100 5.84%
Prepaid expenses 560 0.36% 250 0.16%
Total current 22,860 14.52% 17,950 11.51%
assets
Property and
equipment:
Land 86,000 54.62% 86,000 55.15%
Buildings and 48,600 30.86% 52,000 33.34%
equipment, net
Total property and 134,600 85.48% 138,000 88.49%
equipment
Total assets 157,460 100.00% 155,950 13.47%
Liabilities and
stockholders’
Equity
Current Liabilities
Accounts payable 17,600 11.18% 21,000 13.47%
Accrued expenses 1,620 1.03% 4,430 2.84%
Notes payable, 540 0.34% 220 0.14%
short term
Total current 19,760 12.55% 25,650 16.45%
liabilities
Long-term liabilities
Bonds payable 5,300 3.37% 5,300 3.40%
Notes payable 34,400 21.85% 35,000 22.44%
Total Liabilities 59,460 37.76% 65,950 42.29%
Stockholders’
equity
Common stock 11,000 6.99% 11,000 7.05%
Additional paid-in 19,000 12.07% 19,000 12.18%
capital
Total paid-in capital 30,000 19.05% 30,000 19.24%
Retained earnings 68,000 43.19% 60,000 38.47%
Total stockholders’ 98,000 62.24% 90,000 57.71%
equity
Total liabilities and 157,460 100.00% 155,950 100.00%
stockholders’
equity

b. Present the income statement with each balance as a percent of sales.

Bao Corporation Comparative Balance Sheets December 31, 2018 and 2017
2017 2018
Sales 100.00% 130,000 100.00% 111,000
Cost of goods sold 51.54% 67,000 54.95% 61,000
Gross margin 48.46% 63,000 45.05% 50,000
Operating
expenses:
Selling expenses 18.85% 24,500 18.02% 20,000
Administrative 13.46% 17,500 13.15% 14,600
expenses
Total operating 32.31% 42,000 31.71% 34,600
expenses
Income from 16.15% 21,000 13.87% 15,400
operations
Interest expense 4.31% 5,600 4.23% 4,700
Income before 11.85% 15,400 9.64% 10,700
taxes
Less income taxes 4.74% 6,160 3.86% 4,280
Net income 7.11% 9,240 5.78% 6,240

c. Comment on the results of any significant findings.

There has been significant increase in shareholder’s equity telling us that the company
is operating efficiently.
d. What types of issues does the company seem to be facing?

The company is facing high operating expenses.

e. What suggestions do you have for the Bao Corporation?

I suggest they better control and manage their costs/ expenses.

Problem 14-14. Horizontal Analysis [LO1} Refer to the financial data for Bao
Corporation in Problem 14-13.Using these financial statements, complete the following
steps.

Required

a. Prepare a horizontal analysis for the balance sheet.

Bao Corporation Comparative Balance Sheets December 31,2018, and 2017
2018 2017 Changes Changes in %
Assets
Current assets:
Cash 1,900 1.300 600 46.15%
Accounts 9,100 7,300 1,800 24.66%
receivable, net
Inventory 11,300 9,100 2,200 24.18%
Prepaid expenses 560 250 260 124.00%
Total current assets 22,860 17,950 4,910 27.35%
Property and
equipment:
Land 86,000 86,000 - 0.00%
Buildings and 48,600 52,000 (3,400) -6.54%
equipment, net
Total property and 134,600 138,000 (3,400) -2.46%
equipment
Total assets 157,460 155,950 1,510 0.97%
Liabilities and
stockholders’
Equity
Current Liabilities
Accounts payable 17,600 21,000 (3,400) -16.19%
Accrued expenses 1,620 4,430 2,810 -63.43%
Notes payable, 540 220 320 145.45%
short term
Total current 19,760 25,650 (6,490) -22.96%
liabilities
Long-term liabilities
Bonds payable 5,300 5,300 - 0.00%
Notes payable 34,400 35,000 (600) -1.71%
Total Liabilities 59,460 65,950 (6,490) -9.84%
Stockholders’
equity
Common stock 11,000 11,000 - 0.00%
Additional paid-in 19,000 19,000 - 0.00%
capital
Total paid-in capital 30,000 30,000 - 0.00%
Retained earnings 68,000 60,000 8,000 13.33%
Total stockholders’ 98,000 90,000 8,000 8.89%
equity
Total liabilities and 157,460 155,950 1,510 0.97%
stockholders’ equity

b. Prepare a horizontal analysis for the income statement.

Bao Corporation Comparative Balance Sheets December 31, 2018 and 2017
2018 2017
Sales 130,000 111,000 19,000 17.1%
Cost of goods sold 67,000 61,000 6,000 9.8%
Gross margin 63,000 50,000 13,000 26.0%
Operating
expenses:
Selling expenses 24,500 20,000 4,500 22.5%
Administrative 17,500 14,600 2,900 19.9%
expenses
Total operating 42,000 34,600 7,400 21.4%
expenses
Income from 21,000 15,400 5,600 36.4%
operations
Interest expense 5,600 4,700 900 19.15%
Income before 15,400 10,700 4,700 43.93%
taxes
Less income taxes 6,160 4,280 1,880 43.93%
Net income 9,240 6,240 3,000 43.93%
c. Comment on the results of any significant findings.

There has been significant increase in shareholder’s equity telling us that the company
is operating efficiently.
d. What types of issues does the company seem to be facing?

The company is facing high operating expenses.

e. What suggestions do you have for the Bao Corporation?

I suggest they better control and manage their costs/ expenses.

Problem 14-15. Comprehensive ratio Analysis [LO3] Refer to data in Bao

Corporation in Problem 14-13. You have just been hired as a loan officer at the Sussex
Bank. Your supervisor has given you a file containing a request from Bao Corporation
for a $30,000 five-year loan. Use the financial statements for the Bao Corporation to
answer the questions that follow. Lui Chun, who just a year ago was appointed
president of Bao Corporation, informs you that although the company has had some
problems in the past, it is turning things around, as evidenced by the 17 percent
increase in sales and the improved earnings results between last year and this year.
Ms.Chun feels that, with her leadership and the improved technology (which will come
from the equipment that the $30,000 will allow the company to purchase), profits will be
even stronger in the future. Wanting to succeed in your first assignment, you decide to
gather all the necessary information for a complete analysis. You determine that the
following ratios are typical for the industry in which Bao Corporation operates:

Current ratio 2.6 to 1

Acid-test (quick) ratio 1.2 to 1
Accounts receivable turnover 8.5 times
Inventory turnover 6.2 times
Return on assets 12.1%
Debt-to-equity ratio 0.68 to 1
Times interest earned 6.8

Required

a. Compute each of the above ratios for Bao Corporation.

Current ratio = current assets/current liabilities

2018 $22860 / $19760 1.16
2017 $17950 / 25650 0.70

Acid test= (cash +marketable securities +short-term receivable)/current liabilities

2018 $1900+9100)/$19760 0.56
2017 $(1300+7300)/25650 0.34
Accounts receivable turnover= net credit sales / accounts receivable
2018 $130,000/$9100 14.29
2017 $111,000/$73000 15.21

Inventory Turnover = cost of goods sold / inventory

2018 $67,000/ $11300 5.93
2017 $61,000/ $9100 6.70

Return on assets = (net income + (interest exp x 1 – tax rate))/ total asset
2018 $9240 + (5600* .65) /157460 0.08
2017 $6420 + (4700* .65) /155950 0.06

Debt to equity= total liability / stockholder equity

2018 $59460/$9800 0.61
2017 $65950/90000 0.73

Times interest earned = operating income/ interest expense

2018 $21000/5600 3.75
2017 $15400/4700 3.28

b. Summarize the results of these ratios.

Please refer to solution a

c. Based on this analysis, would you recommend that the loan be approved?

According to the analysis I would recommend the loan because both the acid test and
current ratio are improving and their debt to equity ratio is decreasing indicating that
they can pay their debts.