Finman4e Test Bank Mod 04 050914. Module 4 Analyzing and Interpreting Financial Statements

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Module 4 Analyzing and Interpreting Financial Statements Learning Objectives – coverage by question True/False

Multiple Choice

Exercises

Problems

Essays

LO1 – Compute return on equity (ROE) and disaggregate it into components of operating and nonoperating returns.

1-6

1-9

1-7

1-4

1, 2

LO2 – Disaggregate operating return (RNOA) into components of profitability and asset turnover.

1, 7-9

10-14

8, 9

5, 6

1-3

LO3 – Explain nonoperating return and compute it from return on equity and the operating return.

1, 2, 10, 11

15-17

10

1-3, 7, 8

1, 2, 4

LO4 – Compute and interpret measures of liquidity and solvency.

1, 12, 13

18-24

11-13

9, 10

1, 2, 5, 6

LO5 – Describe and illustrate traditional DuPont disaggregation of ROE.

1, 14, 15

25

14, 15

11

1, 2, 7

Test Bank, Module 4

©Cambridge Business Publishers, 2015 4-1

Module 4: Analyzing and Interpreting Financial Statements

True/False Topic: Use of Ratios LO: 1-5 1. Ratios provide one way to compare companies in the same industry regardless of their size.

Answer: True Rationale: Ratios mitigate problems arising from different sizes of companies.

Topic: Financial Leverage and RNOA LO: 1, 3 2. Highly leveraged firms have higher RNOA than firms with lower leverage.

Answer: False Rationale: Financial leverage does not affect the RNOA computation because it is based on operating profit. Financial leverage will increase ROE, however.

Topic: Return on Equity and Treasury Stock LO: 1 3. Repurchasing shares near year-end will increase a firm’s return on equity (ROE).

Answer: True Rationale: Repurchasing shares will decrease equity because treasury stock is a contra-account (it reduces total equity). If the repurchases happen at year-end, there are likely no significant profit impacts and thus, the numerator in the ROE ratio will be unaffected. Thus, the ratio will increase.

Topic: Nonoperating Return LO: 1 4. All else equal, when investors consider a firm’s return on equity (ROE) they consider less risky a firm that earns proportionately more of that return from operating activities as opposed to nonoperating activities.

Answer: True Rationale: Financial leverage will increase nonoperating return and ROE; however this adds risk to the investment. For equal returns, investors typically prefer less risk.

Topic: Tax on Operating Profit LO: 1 5. To determine tax on net operating profit, we begin with total tax expense and deduct taxes related to net nonoperating expenses.

Answer: False Rationale: We begin with total tax expense and add back any taxes related to net nonoperating expenses (NNE).

©Cambridge Business Publishers, 2015 4-2

Financial & Managerial Accounting for MBAs, 4th Edition

Topic: NOPAT LO: 1 6. NOPAT is equivalent to income from operating activities.

Answer: False Rationale: NOPAT is income from operating activities after tax which excludes nonoperating expenses such as interest expense. Income from operating activities often includes interest expense and is before tax.

Topic: Asset Turnover Effect on RNOA/ROE LO: 2 7. Increasing a company’s net operating asset turnover (NOAT) increases both RNOA and ROE. Answer: True.

Rationale: ROE = RNOA + FLEV × Spread. RNOA is further disaggregated into profit margin × asset turnover. Therefore an increase in asset turnover will yield an increase in RNOA, which will result in an increase in ROE if all other variables remain constant.

Topic: Profitability and RNOA LO: 2 8. If Company A has a higher net operating profit margin (NOPM) than Company B, then Company A’s RNOA will be higher.

Answer: False Rationale: RNOA depends on NOPM but also depends on operating asset productivity (NOAT). If Company B had a much higher operating asset productivity, its RNOA could be higher despite the lower profitability.

Topic: Net Operating Asset Turnover LO: 2 9. Net operating asset turnover (NOAT) measures a company’s profitability.

Answer: False Rationale Net operating asset turnover is a productivity or efficiency concept.

Topic: Financial Leverage and Debt Ratings LO: 3 10. All else being equal, higher financial leverage will decrease a company’s debt rating and increase the interest rate it must pay.

Answer: True Rationale: Higher levels of financial leverage increase the probability of default and of bankruptcy.

This reduces credit ratings and increases costs for borrowed funds.

Topic: Return on Equity (ROE) LO: 3 11. ROE can be disaggregated into operating and nonoperating returns. Nonoperating return will be positive as long as Spread is positive.

Answer: False Rationale: The nonoperating return can be negative (which reduces ROE) if spread is positive and financial leverage (FLEV) is negative.

Test Bank, Module 4

©Cambridge Business Publishers, 2015 4-3

Topic: Current Ratio LO: 4 12. A current ratio greater than 1.0 is generally desirable for a company.

Answer: True Rationale: A company with a current ratio greater than 1.0 indicates positive working capital. In general, companies prefer greater levels of current assets than current liabilities.

Topic: Solvency LO: 4 13. Solvency ratios measure a company’s ability to meet its debt obligations.

Answer: True Rationale: A solvent company is one that can meet its debt obligations including principal and interest payments as they come due.

Topic: ROA versus RNOA LO: 5 14. The only difference between adjusted return on assets (ROA) and return on net operating assets (RNOA) is that the denominator in RNOA is typically smaller than the denominator in ROA because the former is net of operating liabilities.

Answer: False Rationale: It is true that the denominator in RNOA is typically smaller but the other difference between the ratios is that the numerators are different. ROA includes all net income whereas RNOA includes only net profits from operating activities.

Topic: Basic DuPont Analysis LO: 5 15. The DuPont analysis disaggregates return on equity into profitability, efficiency and leverage components.

Answer: True Rationale: The DuPont disaggregation of return on equity is: ROE = Profit margin (PM) × Asset turnover (AT) × Financial leverage (FL). These three terms measure profitability, efficiency and leverage respectively.

©Cambridge Business Publishers, 2015 4-4

Financial & Managerial Accounting for MBAs, 4th Edition

Multiple Choice Topic: ROE Computation LO: 1 1. ROE is computed as: A) Net income attributable to controlling interest / Average equity attributable to controlling interest B) Net income attributable to controlling interest / Net sales C) RNOA + (FLEV × Spread) x NCI ratio D) A and B E) A and C Answer: E Rationale: ROE = Net income attributable to controlling interest / Average equity attributable to controlling interest. This is the most straightforward way to calculate ROE, so A is correct. Answer C is a disaggregation of ROE into its operating and nonoperating components. Thus, the correct answer is E: A and C. Topic: ROE Computation (Numerical calculations required) LO: 1 2. The 2013 balance sheet of E.I. du Pont de Nemours and Company shows average DuPont shareholders’ equity attributable to controlling interest of $13,219 million, net operating profit after tax of $3,145 million, net income attributable to DuPont of $4,848 million, and common shares issued of 1,014 million.

Assume the company has no preferred shares issued. DuPont’s return on equity (ROE) for the year is: A) 20.9% B) 36.7% C) 23.8% D) 36.4% E) There is not enough information to calculate the ratio.

Answer: B Rationale: ROE = Net income/Average shareholders’ equity = $4,848 / $13,219 = 36.7% Topic: ROE Computation (Numerical calculations required) LO: 1 3. The 2013 financial statements of The New York Times Company reveal average shareholders’ equity attributable to controlling interest of $752,618 thousand, net operating profit after tax of $97,898 thousand, net income attributable to The New York Times Company of $65,105 thousand, and average net operating assets of $ 402,427 thousand.

The company’s return on equity (ROE) for the year is: A) 8.7% B) 13.0% C) 16.2% D) 24.3% E) There is not enough information to calculate the ratio.

Answer: A Rationale: ROE = Net income / Average shareholders’ equity = $65,105 / $752,618 = 8.7%

Test Bank, Module 4

©Cambridge Business Publishers, 2015 4-5

Topic: NOA Computation (Numerical calculations required) LO: 1 4. The 2014 balance sheet of Staples, Inc. shows total assets of $11,174,876 thousand, operating assets of $10,682,344 thousand, operating liabilities of $3,929,854 thousand, and shareholders’ equity of $6,132,263 thousand.

Staples’ 2014 net operating assets are: A) $ 7,245,022 thousand B) $ 10,682,344 thousand C) $ 6,752,490 thousand D) $ 6,132,263 thousand E) None of the above Answer: C Rationale: NOA = Operating assets – Operating liabilities = $10,682,344 – $3,929,854 = $6,752,490 Topic: Average NOA Computation (Numerical calculations required) LO: 1 5. The 2013 balance sheet of Whole Foods Market reports operating assets of $4,102 million, operating liabilities of $1,596 million, and total liabilities of $1,660 million.

Whole Food’s average net operating assets for the year are: A) $2,506 million B) $2,442 million C) $3,256 million D) $2,051 million E) There is not enough information to calculate the amount.

Answer: E Rationale: Average net operating assets requires two years of balance sheet data. The question only provided one year’s data, thus, there is not enough information to calculate the amount.

Topic: Tax Shield Computation (Numerical calculations required) LO: 1 6. Mattel Inc.’s 2013 financial statements show operating profit before tax of $1,168,103 thousand, net income of $903,944 thousand, provision for income taxes of $195,184 thousand and net nonoperating expense before tax of $68,975 thousand.

Assume Mattel’s statutory tax rate for 2013 is 37%. Mattel’s 2013 tax shield is: A) $ 43,454 thousand B) $ 25,521 thousand C) $ 264,159 thousand D) $ 238,638 thousand E) None of the above Answer: B Rationale: Tax shield = Net nonoperating expense before tax × statutory tax rate = $68,975 × 37% = $25,521 thousand.

©Cambridge Business Publishers, 2015 4-6

Financial & Managerial Accounting for MBAs, 4th Edition

Topic: Effective Tax Rate Computation (Numerical calculations required) LO: 1 7. Mattel Inc.’s 2013 financial statements show operating profit before tax of $1,168,103 thousand, net income of $903,944 thousand, provision for income taxes of $195,184 thousand and net nonoperating expense before tax of $68,975 thousand.

Assume Mattel’s statutory tax rate for 2013 is 37%. Mattel’s 2013 effective tax rate is: A) 17.8% B) 37.0% C) 19.4% D) 16.7% E) None of the above Answer: A Rationale: Effective tax rate = Provision for income taxes / Income before tax = $195,184 / ($903,944 + $195,184) = 17.8% Topic: NOPAT Definition LO: 1 8. Net operating profit after tax (NOPAT) includes operating revenues less expenses such as: A) Cost of goods sold (COGS) B) Taxes on operating income C) Selling, general and administrative expenses (SG&A) D) After-tax earnings from investments and interest expenses E) All of the above F) A, B and C only Answer: F Rationale: NOPAT is net operating profit after tax. After-tax earnings from investments and interest expenses are not included because they are nonoperating items.

Topic: RNOA Computation (Numerical calculations required) LO: 1 9. The 2013 balance sheet of The New York Times Company shows average shareholders’ equity attributable to controlling interest of $752,618 thousand, net operating profit after tax of $97,898 thousand, net income attributable to The New York Times Company of $65,105 thousand, and average net operating assets of $ 402,427 thousand.

The company’s return on net operating assets (RNOA) for the year is: A) 13.0% B) 16.2% C) 24.3% D) 8.7% E) There is not enough information to calculate the ratio.

Answer: C Rationale: RNOA = NOPAT / average NOA = $97,898 / $402,427 = 24.3%

Test Bank, Module 4

©Cambridge Business Publishers, 2015 4-7

Topic: Nonoperating Return Computation (Numerical calculations required) LO: 2, 3 10. The fiscal 2013 financial statements of Baker Hughes Inc. shows net operating profit margin (NOPM) of 5.59%, net operating asset turnover (NOAT) of 1.06, return on equity of 6.30%, and adjusted return on assets of 4.58%.

What is the company’s nonoperating return?

A) 0.37% B) 0.71% C) 1.45% D) 1.01% E) There is not enough information to calculate the ratio.

Answer: A Rationale: ROE = RNOA + nonoperating return = 6.30% – (5.59% × 1.06) = 0.3746% Topic: Nonoperating Return Computation (Numerical calculations required) LO: 2, 3 11. The 2013 balance sheet of The New York Times Company shows net operating profit margin (NOPM) of 6.2%, net operating asset turnover (NOAT) of 3.35, return on equity of 8.7%, and adjusted return on assets of 2.4%.

What is the company’s nonoperating return?

A) -12.1% B) 0.7% C) -1.8% D) 2.5% E) None of the above Answer: A Rationale: ROE = RNOA + nonoperating return = 8.7% – (6.2% × 3.35) = -12.07% = -12.1% Topic: Net Operating Profit Margin (NOPM) Computation (Numerical calculations required) LO: 2 12. The fiscal year-end 2014 financial statements for Staples, Inc. report revenues of $23,114,263 thousand, net operating profit after tax of $779,262 thousand, net operating assets of $6,752,490 thousand. The fiscal year-end 2013 balance sheet reports net operating assets of $6,920,568 thousand.

Staples’ 2014 net operating profit margin is: A) 29.2% B) 11.5% C) 3.4% D) 12.7% E) There is not enough information to calculate the ratio.

Answer: C Rationale: NOPM = NOPAT / Revenues = $779,262 / $23,114,263 = 3.4%

©Cambridge Business Publishers, 2015 4-8

Financial & Managerial Accounting for MBAs, 4th Edition

Topic: Net Operating Asset Turnover (NOAT) Computation (Numerical calculations required) LO: 2 13. The fiscal 2013 financial statements for Walgreen, Inc., report net sales of $72,217 million, net operating profit after tax of $2,478 million, net operating assets of $21,556 million. The 2012 balance sheet reports net operating assets of $21,465 million.

Walgreen’s 2013 net operating asset turnover is: A) 11.5% B) 3.24 C) 3.43% D) 3.36 E) There is not enough information to calculate the ratio.

Answer: D Rationale: NOAT = Net sales / Average NOA = $72,217 / [($21,556 + $21,465) / 2] = 3.36 Topic: Net Operating Asset Turnover (NOAT) Computation (Numerical calculations required) LO: 2 14. Kroger’s 2013 financial statements show net operating profit after tax of $1,799 million, net income of $1,497 million, sales of $96,751 million, and average net operating assets of $11,529 million.

Kroger’s net operating asset turnover for the year is: A) 1.9% B) 8.11 C) 8.39 D) 11.9% E) There is not enough information to calculate the ratio.

Answer: C Rationale: Net operating asset turnover = Sales / Average net operating assets = $96,751 million / $11,529 million = 8.39.

Topic: NNO Computation (Numerical calculations required) LO: 3 15. The 2013 balance sheet of Microsoft Corp. reports total assets of $142,431 million, operating liabilities of $47,242 million, and total shareholders’ equity of $78,944 million. Microsoft 2013 nonoperating liabilities are: A) $63,487 million B) $16,245 million C) $95,189 million D) $31,702 million E) There is not enough information to calculate the amount.

Answer: B Rationale: Total assets = Operating liabilities + Nonoperating liabilities + Shareholders’ equity Nonoperating liabilities = $142,431 million – $47,242 million – $78,944 million = $16,245 million

Test Bank, Module 4

©Cambridge Business Publishers, 2015 4-9

Topic: Computing Financial Leverage (FLEV) (Numerical calculations required) LO: 3 16. The fiscal 2013 financial statements of Baker Hughes Inc. shows average net operating assets (NOA) of $21,034 million, average net nonoperating obligations (NNO) of $3,442 million, average total liabilities of $9,722 million, and average equity of $17,391 million.

The company’s 2013 financial leverage (FLEV) is: A) 0.462 B) 0.559 C) 0.164 D) 0.198 E) There is not enough information to determine the ratio.

Answer: D Rationale: FLEV = Average NNO / Average equity = $3,442 / $17,391 = 0.198 Topic: Computing Financial Leverage (FLEV) (Numerical calculations required) LO: 3 17. The fiscal 2014 financial statements of Barney Services shows average net operating assets (NOA) of $6,315 million, average net nonoperating obligations (NNO) of $506 million, average total liabilities of $2,618 million, and equity of $4,050 million.

The company’s 2014 financial leverage (FLEV) is: A) 0.087 B) 0.334 C) 0.125 D) 0.080 E) There is not enough information to determine the ratio.

Answer: A Rationale: FLEV = Average NNO / Average equity = $506 / ($6,315 – $506) = 0.087 Topic: Liquidity LO: 4 18. Liquidity refers to: A) The life cycle of the company B) The amount of receivables the company has in the balance sheet C) The amount of financial leverage D) None of the above Answer: D Rationale: Liquidity refers to cash, the amount on hand, the amount generated from operating activities, and the amount that can be raised on relatively short notice.

©Cambridge Business Publishers, 2015 4-10

Financial & Managerial Accounting for MBAs, 4th Edition

Topic: Current Ratio LO: 4 19. The current ratio is a measure of: A) Solvency B) Bankruptcy position C) Short-term debt paying ability D) Leverage Answer: C Rationale: The current ratio is a measure of short-term debt paying ability.

Topic: Liquidity Measure LO: 4 20. Which of the following is a measure of liquidity?

A) Liabilities-to-Equity Ratio = Total Liabilities / Stockholder’s Equity B) Times Interest Earned = Earnings before interest and taxes / Interest Expense C) Quick Ratio = (Cash + Marketable Securities + Accounts Receivable) / Current Liabilities D) Return on net operating assets (RNOA) E) All of the above Answer: C Rationale: The only measure of liquidity listed above is c (Quick Ratio) which is simply a variation of the Current Ratio (Current Ratio = Current Assets / Current Liabilities) to focus on quick assets (cash, securities, and receivables).

Topic: Computing Current Ratio (Numerical calculations required) LO: 4 21. The fiscal 2013 balance sheet for Whole Foods Market reports the following data (in millions). What is the company’s current ratio?

A) B) C) D) E)

Cash and cash equivalents

Accounts receivable

Merchandise inventories

Current assets

Current liabilities

$290

$188

$414

$1,980

$1,088

0.82 1.55 0.44 1.82 None of the above

Answer: D Rationale: Current ratio = Current assets / Current liabilities = $1,980 / $1,088 = 1.82

Test Bank, Module 4

©Cambridge Business Publishers, 2015 4-11

Topic: Computing Quick Ratio (Numerical calculations required) LO: 4 22. The fiscal 2013 balance sheet for Whole Foods Market reports the following data (in millions). What is the company’s quick ratio?

A) B) C) D) E)

Cash and cash equivalents

Accounts receivable

Merchandise inventories

Current assets

Current liabilities

$290

$188

$414

$1,980

$1,088

0.82 1.55 0.44 1.82 None of the above

Answer: C Rationale: Quick ratio = (Cash + Accounts receivable) / Current liabilities = ($290 + $188) / $1,088 = 0.44 Topic: Computing Times Interest Earned Ratio (Numerical calculations required) LO: 4 23. Selected income statement data follow for Harley Davidson, Inc., for the year ended December 31, 2013 (in thousands). What is the company’s times interest earned ratio?

A) B) C) D) E)

Income before provision for income taxes

Interest expense

Statutory tax rate

Provision for income taxes

Net income

$1,114,305

$45,256

37%

$380,312

$733,993

16.2 1.6 17.2 25.6 None of the above

Answer: D Rationale: Times interest earned = ($1,114,305 + $45,256) / $45,256 = 25.6

©Cambridge Business Publishers, 2015 4-12

Financial & Managerial Accounting for MBAs, 4th Edition

Topic: Computing Liabilities-to-Equity Ratio (Numerical calculations required) LO: 4 24. Selected balance sheet data follow for Goodyear Tire & Rubber Company for the year ended December 31, 2013 (in millions). What is the company’s liabilities-to-equity ratio?

A) B) C) D) E)

Total operating liabilities

Total nonoperating liabilities

Total current liabilities

Total liabilities

Total liabilities and shareholders’ equity

$8,847

$6,235

$5,025

$15,082

$17,527

6.17 2.06 3.62 0.86 None of the above

Answer: A Rationale: Liabilities-to-equity ratio = $15,082 / ($17,527 – $15,082) = 6.17 Topic: Computing Traditional DuPont Ratios (Numerical calculations required) LO: 5 25. Selected ratios follow for Baker Hughes Inc. for the year ended December 31, 2013 (in millions).

What is the company’s return on equity (ROE) for the year?

A) B) C) D) E)

Return on net operating assets (RNOA)

Profit margin (PM)

Net operating profit margin (NOPM)

Asset turnover (AT)

Financial leverage (FL)

5.94%

4.90%

5.59%

0.82

1.57

7.20% 7.65% 6.31% 3.83% None of the above

Answer: C Rationale: ROE = PM × AT × FL = 4.90% × 0.82 × 1.57 = 6.31%

Test Bank, Module 4

©Cambridge Business Publishers, 2015 4-13

Exercises Topic: Use financial statements to compute ROE and disaggregate into operating and nonoperating components LO: 1 1. Selected balance sheet and income statement data follow for E.I. DuPont de Nemours and Company (in millions). Use the data to calculate the following: a. Return on equity (ROE) b. Return on net operating assets (RNOA) c. The company’s nonoperating return 2013 Net income attributable to DuPont

2013

2013

2013 Operating liabilities

2012 Net operating assets

2013 Average DuPont shareholders’ equity

NOPAT

Operating assets

$4,862

$3,145

$42,413

$22,751

$15,640

$13,219

Answer: a. ROE = Net income / Average shareholders’ equity = $4,862 / $13,219 = 36.8% b. RNOA = NOPAT / Average net operating assets = $3,145 / [($42,413 - $22,751 + $15,640) / 2] = 17.8% c.

Nonoperating return = ROE – RNOA = 36.8% – 17.8% = 19.0%

Topic: Use financial statements to compute ROE and disaggregate into operating and nonoperating components LO: 1 2. Selected balance sheet and income statement data follow for The New York Times Company for fiscal 2013 (in thousands). Use the data to calculate the following: a. Return on equity (ROE) b. Return on net operating assets (RNOA) c. The company’s nonoperating return 2013 Net income attributable to New York Times common stockholders $65,105

2013

2012 Net operating assets

2013

2012

NOPAT

2013 Net operating assets

Common equity

Common equity

$97,898

$506,896

$302,401

$842,910

$662,325

Answer: a. ROE = Net income / Average equity = $65,105 / [($842,910 + $662,325) / 2] = 8.7% b. RNOA = NOPAT / Average net operating assets = $97,898 / [($506,896 + $302,401) / 2] = 24.2% c.

Nonoperating return = ROE – RNOA = 8.7% – 24.2% = -15.5%

©Cambridge Business Publishers, 2015 4-14

Financial & Managerial Accounting for MBAs, 4th Edition

Topic: Use financial statements to compute tax shield and NOPAT. Note to instructor: In this fiscal year (2013), Staples has net nonoperating expense (the usual situation). The next exercise is for a Staples’ prior year (fiscal 2007) and involves negative nonoperating expense (atypical situation).

LO: 1 3. Use the income statement for Staples, Inc. to compute the following: a. The tax shield b. NOPAT The company’s combined federal and state statutory tax rate is 37.0%.

STAPLES, INC. AND SUBSIDIARIES Consolidated Statement of Income for February 1, 2014 (in thousands) Sales Cost of goods sold and occupancy costs Gross profit Selling, general, and administrative Restructuring charges Amortization of intangibles Total operating expenses Operating income Other nonoperating income (expense): Interest income Interest expense Miscellaneous expense Income from continuing operations before income taxes Income tax expense Net income Loss from discontinued operations Net income attributed to Staples, Inc.

$23,114,263 17,081,978 6,032,285 4,735,294 64,085 55,405 4,854,784 1,177,501 4,733 (119,329) (100) 1,062,805 355,801 707,004 (86,935) $ 620,069

Answer: a. ($119,329 + $100 – $4,733) × 0.370 = $42,438 b. $1,177,501 – ($355,801 + $42,438) = $779,262

Test Bank, Module 4

©Cambridge Business Publishers, 2015 4-15

Topic: Use financial statements to compute tax shield and NOPAT. Note to instructor: In this fiscal year (2007), Staples has negative net nonoperating expense (the atypical situation). The prior exercise uses Staples’ fiscal 2013 information and involves nonoperating expense (the usual situation).

LO: 1 4. Use the income statement for Staples, Inc., to compute the following: a. The tax shield b. NOPAT The company’s combined federal and state statutory tax rate is 37.0%.

STAPLES, INC. AND SUBSIDIARIES Consolidated Statement of Income for February 2, 2008 (in thousands) Sales Cost of goods sold and occupancy costs Gross profit Operating and selling expenses General and administrative expenses Amortization of intangibles Total operating expenses Operating income Other nonoperating income (expense): Interest income Interest expense Miscellaneous expense Income before income taxes and minority interest Income tax expense Income before minority interests Minority interest income Net Income

$19,372,682 13,822,011 5,550,671 3,131,774 854,984 15,664 4,002,422 1,548,249 46,726 (28,335) (2,158) 1,564,482 559,614 1,004,868 802 $ 1,005,670

Answer: a. ($28,335 + $2,158 – $46,726) × 0.370 = -$6,006 b. $1,548,249 – ($559,614 – $6,006) = $994,641

©Cambridge Business Publishers, 2015 4-16

Financial & Managerial Accounting for MBAs, 4th Edition

Topic: Use financial statements to compute net operating assets (NOA).

LO: 1 5. Use the balance sheets for the fiscal 2013 (year ended February 1, 2014) for Staples, Inc. to compute the following: a. Operating assets b. Operating liabilities c. Net operating assets (NOA) STAPLES, INC. AND SUBSIDIARIES Consolidated Balance Sheets (in thousands) Cash and cash equivalents Receivables, net Merchandise inventories, net Deferred income tax asset Prepaid expenses and other current assets Total current assets Net property and equipment Intangible assets, net Goodwill Other assets Total assets

February 1, 2014 $ 492,532 1,838,714 2,328,299 179,566 400,447 5,239,558 1,870,719 382,700 3,233,597 448,302 $11,174,876

Accounts payable Accrued expenses and other current liabilities Debt maturing within one year Total current liabilities Long-term debt Other long-term obligations

$ 1,997,494 1,266,974 103,982 3,368,450 1,000,205 665,386

Common stock Additional paid-in capital Accumulated other comprehensive loss Retained earnings Treasury stock Total Staples, Inc. stockholders' equity Noncontrolling interests Total stockholders’ equity Total liabilities and stockholders' equity

563 4,866,467 (507,154) 7,001,755 (5,229,368) 6,132,263 8,572 6,140,835 $11,174,876

Answer: a. $11,174,876 - $492,532 = $10,682,344 b. $1,997,494 + $1,266,974 + $665,386 = $3,929,854 c.

$10,682,344 - $3,929,854 = $6,752,490

Test Bank, Module 4

©Cambridge Business Publishers, 2015 4-17

Topic: Use financial statements to compute tax amounts.

LO: 1 6. Use the following income statement for Mattel Inc. ($ thousands) to compute the following: a. Tax shield b. Taxes on operating profit c. Tax rate on operating profit The company’s statutory tax rate is 37%.

Mattel Inc. and Subsidiaries Consolidated Statement of Income For the year ended December 31, 2013 Net sales Cost of sales Gross profit Advertising and promotion expenses Other selling and administrative expenses Operating income Interest expense Interest (income) Other nonoperating (income), net Income before income taxes Provision for income taxes Net income

$ 6,484,892 3,006,009 3,478,883 750,205 1,560,575 1,168,103 78,505 (5,555) (3,975) 1,099,128 195,184 $ 903,944

Answer: a. ($78,505 - $5,555 – $3,975) × 37% = $68,975 × 37% = $25,521 b. $195,184 + $25,521 = $220,705 c.

$220,705 / $1,168,103 = 18.9%

©Cambridge Business Publishers, 2015 4-18

Financial & Managerial Accounting for MBAs, 4th Edition

Topic: Use financial statements to compute tax amounts.

Note to instructor: Microsoft has negative nonoperating items and thus a negative tax shield.

LO: 1 7. Use the following income statement for Microsoft Corporation to compute the following: a. Tax shield b. Taxes on operating profit c. Tax rate on operating profit The company’s statutory tax rate is 37%.

Microsoft Corporation Income Statement For the fiscal year ended June 30, 2013 (in millions) Revenue Cost of revenue Research and development Sales and marketing General and administrative Total operating expenses Income from operations Investment income and other Income before income taxes Provision for income taxes Net income

$77,849 20,249 10,411 15,276 5,149 51,085 26,764 288 27,052 5,189 $21,863

Answer: a. -$288 × 37% = -$107 b. $5,189 – $107 = $5,082 c.

$5,082 / $26,764 = 0.1899 = 19.0%

Topic: Use financial statement data to compute RNOA, NOPM, and NOAT. LO: 2 8. Selected balance sheet and income statement data follow for Staples, Inc. (in thousands). Use the data to calculate a) return on net operating assets (RNOA), b) net operating profit margin (NOPM), and c) net operating asset turnover (NOAT) for fiscal 2013.

2013 Revenues

2013 NOPAT

2013 Operating assets

2013 Operating liabilities

2012 Net operating assets

$23,114,263

$779,262

$10,682,344

$3,929,854

$6,749,749

Answer: a. RNOA = NOPAT / Average NOA = $779,262 / [($10,682,344 - $3,929,854 + $6,749,749) / 2] = 11.5% b. NOPM = NOPAT / Revenues = $779,262 / $23,114,263 = 3.4% c. NOAT = Revenues / Average NOA = $23,114,263 / [($10,682,344 - $3,929,854 + $6,749,749) / 2] = 3.42 Test Bank, Module 4

©Cambridge Business Publishers, 2015 4-19

Topic: Use financial statement data to compute RNOA, NOPM, and NOAT, and confirm RNOA. LO: 2 9. Selected balance sheet and income statement data follow for Walgreen Co. for the year ended August 31, 2013 (in millions). Use the data to calculate a) return on net operating assets (RNOA), b) net operating profit margin (NOPM), and c) net operating asset turnover (NOAT). Confirm that RNOA = NOPM × NOAT. 2013

2013

2013 Net earnings

2013 Operating assets

2013 Operating liabilities

2012 Net operating assets

Net Sales

NOPAT

$72,217

$2,478

$2,450

$32,536

$10,980

$21,465

Answer: a. RNOA = NOPAT / Average NOA = $2,478 / [($32,536 - $10,980 + $21,465) / 2] = 11.5% b. NOPM = NOPAT / Net sales = $2,478 / $72,217 = 3.4% c.

NOAT = Net sales / Average NOA = $72,217/ [($32,536 - $10,980 + $21,465) / 2] = 3.4

Confirm RNOA: 3.4% × 3.4.4 = 11.6% (0.1% difference due to rounding) Topic: Use financial statements to compute FLEV and Spread.

Note to instructor: More challenging because students must infer total shareholders’ equity from NNO and NOA. LO: 3 10. Selected income statement and balance sheet data follow for Snap-On Incorporated for fiscal 2013 and 2012. Use these data to calculate a) FLEV, b) spread, and c) return on equity (ROE) for fiscal 2013 only. (in millions) Net nonoperating expenses, after tax (NNE) Net operating assets (NOA) Net nonoperating obligations (NNO) Return on net operating assets (RNOA)

2013 $ 47.0 $2,884.8 $ 754.4 14.5%

2012 $ 41.3 $2,580.1 $ 761.1 14.1%

Answer: a. FLEV = Average NNO / Average shareholders’ equity = [($754.4 + $761.1) / 2] / [(($2,884.8 – $754.4) + ($2,580.1 – $761.1)) / 2] = 0.38 b. Spread = RNOA – (NNE / Average NNO) = 14.5% - $47 / [($754.4 + $761.1) / 2] = 8.3% c.

ROE = RNOA + (FLEV × Spread) = 14.5% + (0.38 × 8.3%) = 17.7%

©Cambridge Business Publishers, 2015 4-20

Financial & Managerial Accounting for MBAs, 4th Edition

Topic: Use financial statement data to compute measures of liquidity.

Note to Instructor: this is more challenging as it requires students to assess whether “Restricted cash” is a quick asset. It is not because it cannot be used to satisfy ordinary current liabilities.

LO: 4 11. Selected balance sheet income statement data follow for Whole Foods Market, Inc. for the year ended September 29, 2013 (in millions). Use the data to calculate the company’s current ratio and quick ratio.

Cash and cash equivalents

Short-term investments

Restricted cash

Accounts receivable

Merchandise inventories

Current assets

Current liabilities

$290

$733

$111

$188

$414

$1,980

$1,088

Answer: Current ratio = $1,980 / $1,088 = 1.82 Quick ratio = (Cash + Marketable securities + Accounts receivable) / Current liabilities = ($290 + $733 + $188) / $1,088 = 1.11 Topic: Use financial statement data to compute measures of solvency LO: 4 12. Selected balance sheet income statement data follow for Harley Davidson, Inc. for the year ended December 31, 2013 (in thousands). Use the data to calculate a) times interest earned, and b) liabilities-to-equity ratio Income before provision for income taxes

Interest expense

Statutory tax rate

Total liabilities

Total shareholders’ equity

$1,114,305

$45,256

37.0%

$6,395,554

$3,009,486

Answer: a. Times interest earned = ($1,114,305 + $45,256) / $45,256 = 25.6 times b. Liabilities-to-equity ratio = $6,395,554 / $3,009,486 = 2.13 Topic: Use financial statement data to compute measures of liquidity and solvency.

LO: 4 13. Selected balance sheet and income statement data follow for Goodyear Tire & Rubber Company for the year ended December 31, 2013 (in millions). Use the data to calculate the company’s current ratio and liabilities-to-equity ratio.

Cash and cash equivalents

Accounts receivable

Total current assets

Total current liabilities

Total liabilities

Total liabilities and shareholders’ equity

$2,996

$2,435

$8,644

$5,025

$15,082

$17,527

Answer: Current ratio = $8,644 / $5,025 = 1.72 Liabilities-to-equity ratio = $15,082 / ($17,527 - $15,082) = 6.17

Test Bank, Module 4

©Cambridge Business Publishers, 2015 4-21

Topic: Use financial statements to compute and interpret traditional DuPont ROE ratio and components.

LO: 5 14. Use the following selected balance sheet and income statement data for Mattel Inc. (in $ thousands) to compute a) return on equity, b) profit margin (PM), c) asset turnover (AT), and d) financial leverage (FL) for fiscal 2013. Show that ROE = PM × AT × FL. (in thousands) Net sales Operating income Interest expense Net income Total assets Total liabilities

2013 $ 6,484,892 1,168,103 5,555 903,944 6,439,626 3,188,067

2012 $ 6,420,881 1,021,015 6,841 776,464 6,526,785 3,459,741

Answer: a. ROE = Net income / Average stockholders’ equity = $903,944 / {[($6,439,626 + $6,526,785) / 2] – [($3,188,067 + $3,459,741) / 2]} = 28.61% b. PM = Net income / Net sales = $903,944 / $6,484,892 = 13.94% c.

AT = Net sales / Average assets = $6,484,892 / [($6,439,626 + $6,526,785) / 2] = 1.00

d. FL = Average assets / Average stockholders’ equity = [($6,439,626 + $6,526,785) / 2] / {[($6,439,626 + $6,526,785) / 2] – [($3,188,067 + $3,459,741) / 2]} = 2.05 ROE = 13.94% × 1.00 × 2.05 = 28.58% (off by 0.03% due to rounding) Topic: Use financial statements to compute and interpret traditional DuPont ROE ratio and components.

LO: 5 15. Use the following selected balance sheet and income statement data for Valero Energy Corporation (in $ millions) to compute a) return on equity, b) profit margin (PM), c) asset turnover (AT), and d) financial leverage (FL) for fiscal 2013. Show that ROE = PM × AT × FL. (Millions of Dollars) Operating revenues Interest expense Net income attributable to Valero stockholders Total assets Total Valero stockholders’ equity Statutory tax rate

2013 $138,074 365 2,720 47,260 19,460 37%

2012 $ 139,250 313 2,090 44,477 18,032 37%

Answer: a. ROE = Net income / Average stockholders’ equity = $2,720 / [($19,460 + $18,032) / 2 ] = 14.51% b. PM = Net income / Revenue = $2,720 / $138,074 = 1.97% c.

AT = Revenue / Average assets = $138,074 / [($47,260 + $44,477) / 2] = 3.01

d. FL = Average assets / Average stockholders’ equity = [($47,260 + $44,477) / 2] / [($19,460 + $18,032) / 2 ] = 2.45 ROE = 1.97% × 3.01 × 2.45 = 14.53% (off by 0.02% due to rounding) ©Cambridge Business Publishers, 2015 4-22

Financial & Managerial Accounting for MBAs, 4th Edition

Problems Topic: Use financial statements to compute ROE and disaggregate into operating and nonoperating components LO: 1, 3 1. Income statements and balance sheets follow for The New York Times Company. Refer to these financial statements to answer the requirements.

The New York Times Company Consolidated Statements of Income

(in thousands) Operating revenues Circulation Advertising Other Total revenues Production Costs Raw materials Wages and benefits Other Total production costs Selling, general and administrative expenses Depreciation and amortization Total operating costs Pension settlement expense Multiemployer pension plan withdrawal expense Other expense Operating profit Gain on sale of investments Impairment of investments (Loss)/income from joint ventures Premium on debt redemption Interest expense, net Income from continuing operations before income taxes Income tax expense Income from continuing operations Discontinued operations: (Loss) from discontinued operations, net of tax Gain on sale, net of tax Income/(loss) from discontinued operations, net of tax Net income/(loss) Net (income)/loss attributable to the noncontrolling interest Net income/(loss) attributable to New York Times Company common stockholders

Fiscal year ended Dec. 29, 2013 Dec. 30, 2012 $ 824,277 666,687 86,266 1,577,230

$ 795,037 711,829 88,475 1,595,341

92,886 332,085 201,942 626,913 706,354 78,477 1,411,744 3,228 6,171 0 156,087 0 0 (3,215) 0 58,073

106,381 331,321 213,616 651,318 711,112 78,980 1,441,410 47,657 0 2,620 103,654 220,275 5,500 2,936 0 62,808

94,799 37,892 56,907

258,557 94,617 163,940

(20,413) 28,362

(113,447) 85,520

7,949 64,856

(27,927) 136,013

249

(166)

65,105

135,847

Continued next page

Test Bank, Module 4

©Cambridge Business Publishers, 2015 4-23

continued The New York Times Company Consolidated Balance Sheets As of Dec. 29, 2013

Dec. 30, 2012

Cash and cash equivalents Short-term investments Accounts receivable, net Deferred income taxes Prepaid assets Other current assets Assets held for sale Total current assets Long-term marketable securities Investments in joint ventures Property plant and equipment, net Goodwill, net Deferred income taxes Miscellaneous assets Total assets

$ 482,745 364,880 202,303 65,859 20,250 36,230 0 1,172,267 176,155 40,213 713,356 125,871 179,989 164,701 $2,572,552

$ 820,490 134,820 197,589 58,214 23,085 26,320 137,050 1,397,568 4,444 40,872 773,469 122,691 302,212 166,214 $2,807,470

Accounts payable Accrued payroll and other related liabilities Unexpired subscriptions Accrued expenses Accrued incomes taxes Liabilities held for sale Total current liabilities

$ 90,982 91,629 58,007 107,755 138 0 348,511

$ 88,990 86,772 57,336 118,753 38,932 32,373 423,156

Long-term debt and capital lease obligations Pension benefits obligation Postretirement benefits obligation Other Total other liabilities

684,142 444,328 90,602 158,435 1,377,507

696,752 737,889 110,347 173,690 1,718,678

15,129 82 33,045 1,283,518 (86,253)

15,027 82 25,610 1,230,450 (96,278)

(402,611) 842,910 3,624 846,534 $2,572,552

(512,566) 662,325 3,311 665,636 $2,807,470

(in thousands)

Stockholders’ equity Common stock of $0.10 par value: Class A common stock Class B convertible Additional paid-in capital Retained earnings Common stock held in treasury, at cost Accumulated other comprehensive income loss), net of tax Total New York Times Company stockholders’ equity Noncontrolling interest Total stockholders’ equity Total liabilities and stockholders’ equity Continued next page ©Cambridge Business Publishers, 2015 4-24

Financial & Managerial Accounting for MBAs, 4th Edition

continued Required: a. Compute net operating profit after tax (NOPAT) for 2013 and 2012. Assume that combined federal and state statutory tax rates are 37% for both years. b. Compute net operating assets (NOA) for 2013 and 2012. c. Compute return on net operating assets (RNOA) for 2013 and 2012. Net operating assets are $412,630 thousand in 2011. d. Compute return on common shareholders equity (ROE) for 2013 and 2012. Stockholders’ equity attributable to New York Times Company in 2011 is $506,360 thousand. e. What is nonoperating return component of ROE for 2013 and 2012? f. Comment on the difference between ROE and RNOA. What inference do you draw from this comparison?

Answer: a. (in thousands) Income from operations Income/(loss) from joint ventures Provision for income taxes Tax shelter on nonoperating items NOPAT

2013 $156,087 (3,215) (37,892) (21,487) $ 93,493

2012 $ 103,654 2,936 (94,617) 56,228 $68,201

b. (in thousands) Total assets Less Cash and cash equivalents Less Short-term marketable securities Less Assets held for sale Less Long-term marketable securities Operating assets

2013 $2,572,552 (482,745) (364,880) 0 (176,155) 1,548,772

2012 $2,807,470 (820,490) (134,820) (137,050) (4,444) 1,710,666

Total current liabilities Less Liabilities held for sale Plus Pension benefits obligation Plus Postretirement benefits obligation Plus Other liabilities Operating liabilities Net operating assets (NOA)

348,511 0 444,328 90,602 158,435 1,041,876 $506,896

423,156 (32,373) 737,889 110,347 173,690 1,412,709 $297,957

c.

2013: $93,493 / [($506,896 + $297,957) / 2] = 23.2% 2012: $68,201 / [($297,957 + $412,630) / 2] = 19.2%

d. 2013: $65,105 / [($842,910 + $662,325) / 2] = 8.7% 2012: $135,847 / [($662,325 + $506,360) / 2] = 23.2% e. ROE = RNOA + Nonoperating return 2013: 8.7% = 23.2% – 14.5% 2012: 23.2% = 19.2% + 4.0% f.

The company had a positive nonoperating return in 2012, implying the company made effective use of leverage. For 2013, the company’s nonoperating return is negative as its investment in marketable securities exceeds its nonoperating debt.

Test Bank, Module 4

©Cambridge Business Publishers, 2015 4-25

Topic: Use financial statements to compute ROE and disaggregate into operating and nonoperating components LO: 1, 3 2. Income statements and balance sheets follow for Snap-On Incorporated. Refer to these financial statements to answer the requirements.

Snap-On Incorporated Consolidated Statements of Earnings

Net sales Cost of goods sold Gross profit Operating expenses Operating earnings before financial services

For the fiscal year ended 2013 2012 $ 3,056.5 $ 2,937.9 (1,583.6) (1,547.9) 1,472.9 1,390.0 (1,012.4) (980.3) 460.5 409.7

Financial services revenue Financial services expenses Operating income from financial services Operating earnings Interest expense Other income (expense) -- net Earnings before income taxes and equity earnings Income tax expense Earnings before equity earnings Equity earnings, net of tax Net earnings Net earnings attributable to noncontrolling interests Net earnings attributable to Snap-on Incorporated

181.0 (55.3) 125.7 586.2 (56.1) (3.9) 526.2 (166.7) 359.5 0.2 359.7 (9.4) $ 350.3

(Amounts in millions)

161.3 (54.6) 106.7 516.4 (55.8) (0.4) 460.2 (148.2) 312.0 2.6 314.6 (8.5) $ 306.1

Continued next page

©Cambridge Business Publishers, 2015 4-26

Financial & Managerial Accounting for MBAs, 4th Edition

continued Snap-On Incorporated Consolidated Balance Sheets Fiscal Year End 2013

(Amounts in millions)

217.6 531.6 374.6 68.4 434.4 85.4 84.2 1,796.2 392.5 57.1 560.6 217.1 838.8 190.5 57.2 $ 4,110.0

2012

Cash and cash equivalents Trade and other accounts receivable - net Finance receivables - net Contract receivables - net Inventories - net Deferred income tax assets Prepaid expenses and other assets Total current assets Property and equipment - net Deferred income tax assets Long-term finance receivables - net Long-term contract receivables - net Goodwill Other intangibles - net Other assets Total assets

$

$

214.5 497.9 323.1 62.7 404.2 81.8 84.8 1,669.0 375.2 110.4 494.6 194.4 807.4 187.2 64.1 $ 3,902.3

Notes payable and current maturities of long-term debt Accounts payable Accrued benefits Accrued compensation Franchisee deposits Other accrued liabilities Total current liabilities Long-term debt Deferred income tax liabilities Retiree health care benefits Pension liabilities Other long-term liabilities Total liabilities

$

113.1 155.6 48.1 95.5 59.4 243.7 715.4 858.9 143.8 41.7 135.8 84.0 1,979.6

$ 5.2 142.5 50.6 88.3 54.7 247.9 589.2 970.4 127.1 48.4 260.7 87.5 2,083.3

Preferred stock Common stock Additional paid-in capital Retained earnings Accumulated other comprehensive income (loss) Treasury stock at cost Total shareholders’ equity attributable to Snap-on Inc. Noncontrolling interests Total shareholders’ equity Total liabilities and shareholders’ equity

– 67.4 225.1 2,324.1 (44.8) (458.6) 2,113.2 17.2 2,130.4 $ 4,110.0

– 67.4 204.6 2,067.0 (124.2) (412.7) 1,802.1 16.9 1,819.0 $ 3,902.3

Continued next page Test Bank, Module 4

©Cambridge Business Publishers, 2015 4-27

continued Required: a. Compute net operating profit after tax (NOPAT) for 2013 and 2012. Assume that combined federal and state statutory tax rates are 37% for fiscal 2013 and 2012. b. Compute net operating assets (NOA) for 2013 and 2012. c. Compute return on net operating assets (RNOA) for 2013 and 2012. Net operating assets are $2,329.6 million in 2011. d. Compute return on equity (ROE) for 2013 and 2012. (Stockholders’ equity attributable to Snap-On in 2011 is $1,530.9 million.) e. What is nonoperating return component of ROE for 2013 and 2012? f. Comment on the difference between ROE and RNOA. What inference do you draw from this comparison?

Answer: a . (Amounts in millions) Income from operations Equity in earnings (losses) of affiliates Provision for income taxes Tax shelter on nonoperating items NOPAT b .

(Amounts in millions) Operating assets (Total assets - Cash and cash equiv.)

Total liabilities Nonoperating liabilities Operating liabilities Net operating assets (NOA)

c.

2013 $ 586.2 0.2 (166.7) (22.2) $ 397.5 2013

2012 $ 516.4 2.6 (148.2) (20.8) $ 350.0 2012

3,892.4 1,979.6 972.0 1,007.6

$3,687.8 2,083.3 975.6 1,107.7

$2,884.8

$2,580.1

2013: $397.5 / [($2,884.8 + $2,580.1) / 2] = 14.5% 2012: $350.0 / [($2,580.1 + $2,329.6) / 2] = 14.3%

d. 2013: $350.3 / [($2,113.2 + $1,802.1) / 2] = 17.9% 2012: $306.1 / [($1,802.1 + $1,530.9) / 2] = 18.4% e. ROE = RNOA + Nonoperating return 2013: 17.9% = 14.5% + 3.4% 2012: 18.4% = 14.3% + 4.1% f.

The company has a positive nonoperating return both years, which implies that the company makes effective use of leverage. The company’s debt costs less (in percentage terms) than the operating assets earn, therefore, shareholders’ return is increased.

©Cambridge Business Publishers, 2015 4-28

Financial & Managerial Accounting for MBAs, 4th Edition

Topic: Use financial statements to compute ROE and disaggregate into operating and nonoperating components LO: 1, 3 3. Income statements and balance sheets follow for E.I. DuPont de Nemours and Company. Refer to these financial statements to answer the requirements.

E. I. du Pont de Nemours and Company Consolidated Income Statements For The Year Ended December 31, ($ millions) Net sales Other income, net Total Cost of goods sold and other operating charges Selling, general and administrative expenses Research and development expense Interest expense Employee separation/asset related charges(income), net Total expenses Income from continuing operations before income taxes Provision for income taxes on continuing operations Income from continuing operations after income taxes Income from discontinued operations after income taxes Net income Less: Net income attributable to noncontrolling interests Net income attributable to DuPont

2013

2012

$ 35,734 410 36,144

$ 34,812 498 35,310

26,386 3,554 2,153 448

25,615 3,527 2,123

114 32,655

493 32,222

3,489

3,088

626

616

2,863

2,472

1,999 4,862

2,780

14 $ 4,848

25 $ 2,755

Continued next page

Test Bank, Module 4

©Cambridge Business Publishers, 2015 4-29

continued E. I. du Pont de Nemours and Company Consolidated Balance Sheets As of December 31, ($ millions) Current assets Cash and cash equivalents Marketable securities Accounts and notes receivable, net Inventories Prepaid expenses Deferred income taxes Assets held for sale Total current assets

2013

2012

$ 8,941 145 6,047 8,042 206 775 228 24,384

$ 4,284 123 5,452 7,565 204 613 3,076 21,317

Net property, plant and equipment Goodwill Other intangible assets Investment in affiliates Deferred income taxes Other assets Total assets

12,993 4,713 5,096 1,011 2,353 949 $ 51,499

12,741 4,616 5,126 1,163 3,936 960 $ 49,859

$ 5,180

$ 4,853

1,721 247 6,219 0 13,367

1,275 343 5,997 1,084 13,552

10,741 10,179 926 35,213

10,465 14,687 856 39,560

304 11,072 16,784 (5,441) (6,727) 16,229 57 16,286 $ 51,499

306 10,655 14,383 (8,646) (6,727) 10,208 91 10,299 $ 49,859

Current liabilities Accounts payable Short-term borrowings and capital lease obligations Income taxes Other accrued liabilities Liabilities related to assets held for sale Total current liabilities Long-term borrowings and capital lease obligations Other liabilities Deferred income taxes Total liabilities Common stock– 1,004,351,000 Additional paid-in capital Reinvested earnings Accumulated other comprehensive loss Common stock held in treasury Total DuPont stockholders’ equity Noncontrolling interests Total equity Total liabilities and stockholders’ equity Continued next page ©Cambridge Business Publishers, 2015 4-30

Financial & Managerial Accounting for MBAs, 4th Edition

continued Required a. Compute net operating profit after tax (NOPAT) for 2013 and 2012. Assume that combined federal and state statutory tax rate is 37% for both years. b. Compute net operating assets (NOA) for 2013 and 2012. c. Compute return on net operating assets (RNOA) for 2013 and 2012. Net operating assets are $17,596 million in 2011. d. Compute return on equity (ROE) for 2013 and 2012. DuPont Stockholders’ equity in 2011 is $8,593 million. e. What is nonoperating return component of ROE for 2013 and 2012? f. Comment on the difference between ROE and RNOA. What inference do you draw from this comparison?

Answer: a . ($ millions) Income from continuing operations before interest and taxes Provision for income taxes Tax shelter on interest expense NOPAT

2013

2012

$3,937 (626) (166) $3,145

$3,552 (616) (172) $2,764

b .

2013

c.

2012

($ millions) Operating assets Total assets Less Cash and cash equivalents Less Marketable securities Less Assets held for sale Operating assets

$51,499 8,941 145 228 42,185

$49,859 4,284 123 3,076 42,376

Total liabilities Less Short-term borrowings and capital leases Less Liabilities related to assets held for sale Less Long-term borrowings and capital leases Operating liabilities Net operating assets (NOA)

35,213 1,721 0 10,741 22,751 $19,434

39,560 1,275 1,084 10,456 26,745 $15,631

2013: $3,145 / [($19,434 + $15,631) / 2] = 17.9% 2012: $2,764 / [($15,631 + $17,596) / 2] = 16.6%

d. 2013: $4,848 / [($16,229 + $10,208) / 2] = 36.7% 2012: $2,755 / [($10,208 + $8,593) / 2] = 29.3% e. ROE = RNOA + Nonoperating return 2013: 36.7% = 17.9% + 18.8% 2012: 29.3% = 16.6% + 12.7% f.

The company has a positive nonoperating return both years, which implies that the company makes effective use of leverage. The company’s debt costs less (in percentage terms) than the operating assets earn; therefore, shareholders’ return is increased. However, nearly one-third of the total ROE comes from nonoperating return. This could mean that the company has very high debt levels. Alternatively, it could mean that equity is comparatively low (perhaps due to extensive stock buybacks).

Test Bank, Module 4

©Cambridge Business Publishers, 2015 4-31

Topic: Use financial statements to compute ROE and disaggregate into operating and nonoperating components.

LO: 1 4. Income statements and balance sheets follow for Microsoft Corporation. Refer to these financial statements to answer the requirements.

Microsoft Corporation Income Statements Year ended June 30, 2013 2012 $77,849 $73,723 20,249 17,530 57,600 56,193 10,411 9,811 15,276 13,857 5,149 4,569 0 6,193 30,836 34,430 26,764 21,763

(in millions) Revenue Cost of revenue Gross profit Research and development Sales and marketing General and administrative Goodwill impairment Total operating expenses Operating income Other income Income before income taxes Provision for income taxes Net income

288 27,052 5,189 $21,863

504 22,267 5,289 $16,978

Microsoft Corporation Balance Sheets ($ millions) Cash and cash equivalents Short-term investments Accounts receivable, net Inventories Deferred income taxes Other current assets Total current assets

As of June 30, 2013 2012 $ 3,804 $ 6,938 73,218 56,102 17,486 15,780 1,938 1,137 1,632 2,035 3,388 3,092 101,466 85,084

Property plant and equipment, net Equity and other investments Goodwill Intangible assets, net Other long-term assets Total assets

9,991 10,844 14,655 3,083 2,392 $142,431

8,269 9,776 13,452 3,170 1,520 $121,271

Table continued next page

©Cambridge Business Publishers, 2015 4-32

Financial & Managerial Accounting for MBAs, 4th Edition

table continued Microsoft Corporation Balance Sheets (continued) ($ millions) Accounts payable Short-term debt Accrued compensation Income taxes Short-term unearned revenue Securities lending payable Other Current liabilities Long-term debt Long-term unearned revenue Deferred income taxes Other long-term liabilities Total liabilities

As of June 30, 2013 $ 4,828 2,999 4,117 592 20,639 645 3,597 37,417 12,601 1,760 1,709 10,000 63,487

Common stock and paid-in capital Retained earnings/(deficit) Accumulated other comprehensive income Total equity Total liabilities and equity

67,306 9,895 1,743 78,944 $142,431

2012 $ 4,175 1,231 3,875 789 18,653 814 3,151 32,688 10,713 1,406 1,893 8,208 54,908 65,797 (856) 1,422 66,363 $ 121,271

Required: a. Compute net operating profit after tax (NOPAT) for 2013 and 2012. Assume that combined federal and state statutory tax rates are 37% for both years. b. Compute net operating assets (NOA) for 2013 and 2012. Assume Equity and other investments are operating assets. c. Compute return on net operating assets (RNOA) for 2013 and 2012. Net operating assets are $17,440 million in 2011. d. Compute return on equity (ROE) for 2013 and 2012. (Stockholders’ equity in 2011 is $57,083 million.) e. What is nonoperating return component of ROE for 2013 and 2012? f. Comment on the difference between ROE and RNOA. What inference do you draw from this comparison?

Test Bank, Module 4

©Cambridge Business Publishers, 2015 4-33

Answer: a . ($ millions) Operating income Provision for income taxes Tax shelter on nonoperating items NOPAT

2013 $ 26,764 (5,189) 107 $ 21,682

2012 $ 21,763 (5,289) 186 $ 16,660

b. ($ millions) Total assets Less cash and cash equivalents Less short-term investments Operating assets

2013 $142,431 3,804 73,218 65,409

2012 $121,271 6,938 56,102 58,231

Total liabilities Less short-term debt Less securities lending payable Less long-term debt Operating liabilities Net operating assets (NOA)

63,487 2,999 645 12,601 47,242 $ 18,167

54,908 1,231 814 10,713 42,150 $ 16,081

c.

2013: $21,682 / [($18,167 + $16,081) / 2] = 126.6% 2012: $16,660 / [($16,081 + $17,440) / 2] = 99.4%

d. 2013: $21,863 / [($78,944 + $66,363) / 2] = 30.1% 2012: $16,978 / [($66,363 + $57,083) / 2] = 27.5% e. Return on equity = RNOA + Nonoperating return 2013: 30.1% = 126.6% - 96.5% 2012: 27.5% = 99.4% - 71.9% f.

Nonoperating return is negative. This implies that Microsoft has no nonoperating liabilities, the concept of leverage works in reverse. By holding significant levels of marketable securities, the company reduces shareholder return because the nonoperating assets earn a lower return as compared to the operating assets. But, the marketable securities afford the company liquidity so that it can respond to investment opportunities and weather economic downturns.

©Cambridge Business Publishers, 2015 4-34

Financial & Managerial Accounting for MBAs, 4th Edition

Topic: Use financial statements to compute RNOA and disaggregate into components of profitability and asset turnover LO: 2 5. Income statements and balance sheets follow for The New York Times Company. Refer to these financial statements to answer the requirements.

The New York Times Company Consolidated Statements of Income

(in thousands) Operating revenues Circulation Advertising Other Total revenues Production Costs Raw materials Wages and benefits Other Total production costs Selling, general and administrative expenses Depreciation and amortization Total operating costs Pension settlement expense Multiemployer pension plan withdrawal expense Other expense Operating profit Gain on sale of investments Impairment of investments (Loss)/income from joint ventures Premium on debt redemption Interest expense, net Income from continuing operations before income taxes Income tax expense Income from continuing operations Discontinued operations: (Loss) from discontinued operations, net of tax Gain on sale, net of tax Income/(loss) from discontinued operations, net of tax Net income/(loss) Net (income)/loss attributable to the noncontrolling interest Net income/(loss) attributable to New York Times Company common stockholders

Fiscal year ended Dec. 29, 2013 Dec. 30, 2012 $ 824,277 666,687 86,266 1,577,230

$ 795,037 711,829 88,475 1,595,341

92,886 332,085 201,942 626,913 706,354 78,477 1,411,744 3,228 6,171 0 156,087 0 0 (3,215) 0 58,073

106,381 331,321 213,616 651,318 711,112 78,980 1,441,410 47,657 0 2,620 103,654 220,275 5,500 2,936 0 62,808

94,799 37,892 56,907

258,557 94,617 163,940

(20,413) 28,362

(113,447) 85,520

7,949 64,856

(27,927) 136,013

249

(166)

65,105

135,847

Continued next page

Test Bank, Module 4

©Cambridge Business Publishers, 2015 4-35

continued THE NEW YORK TIMES COMPANY CONSOLIDATED BALANCE SHEETS As of Dec. 29, 2013

Dec. 30, 2012

Cash and cash equivalents Short-term investments Accounts receivable, net Deferred income taxes Prepaid assets Other current assets Assets held for sale Total current assets Long-term marketable securities Investments in joint ventures Property, plant and equipment, net Goodwill, net Deferred income taxes Miscellaneous assets Total assets

$ 482,745 364,880 202,303 65,859 20,250 36,230 0 1,172,267 176,155 40,213 713,356 125,871 179,989 164,701 $2,572,552

$ 820,490 134,820 197,589 58,214 23,085 26,320 137,050 1,397,568 4,444 40,872 773,469 122,691 302,212 166,214 $2,807,470

Accounts payable Accrued payroll and other related liabilities Unexpired subscriptions Accrued expenses Accrued incomes taxes Liabilities held for sale Total current liabilities

$ 90,982 91,629 58,007 107,755 138 0 348,511

$ 88,990 86,772 57,336 118,753 38,932 32,373 423,156

Long-term debt and capital lease obligations Pension benefits obligation Postretirement benefits obligation Other Total other liabilities

684,142 444,328 90,602 158,435 1,377,507

696,752 737,889 110,347 173,690 1,718,678

15,129 82 33,045 1,283,518 (86,253)

15,027 82 25,610 1,230,450 (96,278)

(402,611) 842,910 3,624 846,534 $2,572,552

(512,566) 662,325 3,311 665,636 $2,807,470

(in thousands)

Stockholders’ equity Common stock of $0.10 par value: Class A common Class B - convertible Additional paid-in capital Retained earnings Common stock held in treasury, at cost Accumulated other comprehensive income (loss), net of tax Total New York Times Company stockholders’ equity Noncontrolling interest Total stockholders’ equity Total liabilities and stockholders’ equity Continued next page ©Cambridge Business Publishers, 2015 4-36

Financial & Managerial Accounting for MBAs, 4th Edition

continued Required: a. Compute net operating profit after tax (NOPAT) for 2013 and 2012. Assume that combined federal and state statutory tax rates are 37% for both years. b. Compute net operating assets (NOA) for 2013 and 2012. c. Compute return on net operating assets (RNOA) for 2013 and 2012. Comment on the year-overyear change. Net operating assets are $412,630 thousand in 2011. d. Disaggregate RNOA into profitability and asset turnover components (NOPM and NOAT, respectively). What explains the year-over-year change in RNOA? Answer: a . (in thousands) Income from operations Income/(loss) from joint ventures Provision for income taxes Tax shelter on nonoperating items NOPAT

b.

c.

2013 $156,087 (3,215) (37,892) (21,487) $ 93,493

2012 $ 103,654 2,936 (94,617) 56,228 $68,201

(in thousands) Total assets Less Cash and cash equivalents Less Short-term marketable securities Less Assets held for sale Less Long-term marketable securities Operating assets

2013 $2,572,552 (482,745) (364,880) 0 (176,155) 1,548,772

2012 $2,807,470 (820,490) (134,820) (137,050) (4,444) 1,710,666

Total current liabilities Less Liabilities held for sale Plus Pension benefits obligation Plus Postretirement benefits obligation Plus Other liabilities Operating liabilities Net operating assets (NOA)

348,511 0 444,328 90,602 158,435 1,041,876 $506,896

423,156 (32,373) 737,889 110,347 173,690 1,412,709 $297,957

2013: $93,493 / [($506,896 + $297,957) / 2] = 23.2% 2012: $68,201 / [($297,957 + $412,630) / 2] = 19.2% RNOA increased in 2013, from 19.2% to 23.2%.

d. Net operating profit margin (NOPM) 2013: $93,493 / $1,577,230 = 5.9% 2012: $68,201 / $1,595,341 = 4.3% Net operating asset turnover (NOAT) 2013: $1,577,230 / [($506,896 + $297,957) / 2] = 3.92 2012: $1,595,341 / [($297,957 + $412,630) / 2] = 4.49 RNOA increased in 2013 from 19.2% to 23.2%. The increase can be contributed in part to the increase in profit margin from 4.3% to 5.9%. The company was more profitable in 2013 as compared to 2012, but less efficient, based on the decrease in NOAT in 2013.

Test Bank, Module 4

©Cambridge Business Publishers, 2015 4-37

Topic: Use financial statements to compute RNOA and disaggregate into components of profitability and asset turnover LO: 2 6. Income statements and balance sheets follow for Snap-On Incorporated. Refer to these financial statements to answer the requirements.

Snap-On Incorporated Consolidated Statements of Earnings

Net sales Cost of goods sold Gross profit Operating expenses Operating earnings before financial services

For the fiscal year ended 2013 2012 $ 3,056.5 $ 2,937.9 (1,583.6) (1,547.9) 1,472.9 1,390.0 (1,012.4) (980.3) 460.5 409.7

Financial services revenue Financial services expenses Operating income from financial services Operating earnings Interest expense Other income (expense) -- net Earnings before income taxes and equity earnings Income tax expense Earnings before equity earnings Equity earnings, net of tax Net earnings Net earnings attributable to noncontrolling interests Net earnings attributable to Snap-on Incorporated

181.0 (55.3) 125.7 586.2 (56.1) (3.9) 526.2 (166.7) 359.5 0.2 359.7 (9.4) $ 350.3

(Amounts in millions)

161.3 (54.6) 106.7 516.4 (55.8) (0.4) 460.2 (148.2) 312.0 2.6 314.6 (8.5) $ 306.1

Continued next page

©Cambridge Business Publishers, 2015 4-38

Financial & Managerial Accounting for MBAs, 4th Edition

continued Snap-On Incorporated Consolidated Balance Sheets Fiscal Year End 2013

(Amounts in millions)

217.6 531.6 374.6 68.4 434.4 85.4 84.2 1,796.2 392.5 57.1 560.6 217.1 838.8 190.5 57.2 $ 4,110.0

2012

Cash and cash equivalents Trade and other accounts receivable - net Finance receivables - net Contract receivables - net Inventories - net Deferred income tax assets Prepaid expenses and other assets Total current assets Property and equipment - net Deferred income tax assets Long-term finance receivables - net Long-term contract receivables - net Goodwill Other intangibles - net Other assets Total assets

$

$

214.5 497.9 323.1 62.7 404.2 81.8 84.8 1,669.0 375.2 110.4 494.6 194.4 807.4 187.2 64.1 $ 3,902.3

Notes payable and current maturities of long-term debt Accounts payable Accrued benefits Accrued compensation Franchisee deposits Other accrued liabilities Total current liabilities Long-term debt Deferred income tax liabilities Retiree health care benefits Pension liabilities Other long-term liabilities Total liabilities

$

113.1 155.6 48.1 95.5 59.4 243.7 715.4 858.9 143.8 41.7 135.8 84.0 1,979.6

$ 5.2 142.5 50.6 88.3 54.7 247.9 589.2 970.4 127.1 48.4 260.7 87.5 2,083.3

Preferred stock Common stock Additional paid-in capital Retained earnings Accumulated other comprehensive income (loss) Treasury stock at cost Total shareholders’ equity attributable to Snap-on Inc. Noncontrolling interests Total shareholders’ equity Total liabilities and shareholders’ equity

– 67.4 225.1 2,324.1 (44.8) (458.6) 2,113.2 17.2 2,130.4 $ 4,110.0

– 67.4 204.6 2,067.0 (124.2) (412.7) 1,802.1 16.9 1,819.0 $ 3,902.3

Continued next page Test Bank, Module 4

©Cambridge Business Publishers, 2015 4-39

continued Required: a. Compute net operating profit after tax (NOPAT) for 2013 and 2012. Assume that combined federal and state statutory tax rate is 37% for both fiscal years. b. Compute net operating assets (NOA) for 2013 and 2012. c. Compute return on net operating assets (RNOA) for 2013 and 2012. Comment on the year-overyear change. Net operating assets are $2,329.6 million in 2011. d. Disaggregate RNOA into profitability and asset turnover components (NOPM and NOAT, respectively). Remember to include both net sales and financial services revenue in total revenue. What explains the year-over-year change in RNOA? Answer: a . (Amounts in millions) Income from operations Equity in earnings (losses) of affiliates Provision for income taxes Tax shelter on nonoperating items NOPAT b .

c.

2013 $ 586.2 0.2 (166.7) (22.2) $ 397.5

2012 $ 516.4 2.6 (148.2) (20.8) $ 350.0

(Amounts in millions) Operating assets (Total assets - Cash and cash equiv.)

Total liabilities Nonoperating liabilities Operating liabilities

2013

2012

3,892.4 1,979.6 972 1,007.6

$3,687.8 2,083.3 975.6 1,107.7

Net operating assets (NOA)

$2,884.8

$2,580.1

2013: $397.5 / [($2,884.8 + $2,580.1) / 2] = 14.5% 2012: $350.0 / [($2,580.1 + $2,329.6) / 2] = 14.3% RNOA slightly increased in 2013 from 14.3% to 14.5%.

d. Net operating profit margin (NOPM) 2013: $397.5 / $3,237.5 = 12.2% 2012: $350.0 / $3,099.2 = 11.3% Net operating asset turnover (NOAT) 2013: $3,237.5 / [($2,884.8 + $2,580.1) / 2] = 1.18 2012: $3,099.2 / [($2,580.1 + $2,329.6) / 2] = 1.26 RNOA slightly increased in 2013 from 14.3% to 14.5%. Overall return increased due to improved profit margin (from 11.3% to 12.2%) despite the slight decrease in asset turnover (from 1.26 to 11.18). The company was more profitable and slightly less efficient in 2013 as compared to 2012.

©Cambridge Business Publishers, 2015 4-40

Financial & Managerial Accounting for MBAs, 4th Edition

Topic: Use financial statements to compute FLEV and Spread and reconcile to ROE for two years LO: 3 7. Income statements and balance sheets follow for Snap-On Incorporated. Refer to these financial statements to answer the requirements.

Snap-On Incorporated Consolidated Statements of Earnings

Net sales Cost of goods sold Gross profit Operating expenses Operating earnings before financial services

For the fiscal year ended 2013 2012 $ 3,056.5 $ 2,937.9 (1,583.6) (1,547.9) 1,472.9 1,390.0 (1,012.4) (980.3) 460.5 409.7

Financial services revenue Financial services expenses Operating income from financial services Operating earnings Interest expense Other income (expense) -- net Earnings before income taxes and equity earnings Income tax expense Earnings before equity earnings Equity earnings, net of tax Net earnings Net earnings attributable to noncontrolling interests Net earnings attributable to Snap-on Incorporated

181.0 (55.3) 125.7 586.2 (56.1) (3.9) 526.2 (166.7) 359.5 0.2 359.7 (9.4) $ 350.3

(Amounts in millions)

161.3 (54.6) 106.7 516.4 (55.8) (0.4) 460.2 (148.2) 312.0 2.6 314.6 (8.5) $ 306.1

Continued next page

Test Bank, Module 4

©Cambridge Business Publishers, 2015 4-41

continued Snap-On Incorporated Consolidated Balance Sheets Fiscal Year End 2013

(Amounts in millions)

217.6 531.6 374.6 68.4 434.4 85.4 84.2 1,796.2 392.5 57.1 560.6 217.1 838.8 190.5 57.2 $ 4,110.0

2012

Cash and cash equivalents Trade and other accounts receivable - net Finance receivables - net Contract receivables - net Inventories - net Deferred income tax assets Prepaid expenses and other assets Total current assets Property and equipment - net Deferred income tax assets Long-term finance receivables - net Long-term contract receivables - net Goodwill Other intangibles - net Other assets Total assets

$

$

214.5 497.9 323.1 62.7 404.2 81.8 84.8 1,669.0 375.2 110.4 494.6 194.4 807.4 187.2 64.1 $ 3,902.3

Notes payable and current maturities of long-term debt Accounts payable Accrued benefits Accrued compensation Franchisee deposits Other accrued liabilities Total current liabilities Long-term debt Deferred income tax liabilities Retiree health care benefits Pension liabilities Other long-term liabilities Total liabilities

$

113.1 155.6 48.1 95.5 59.4 243.7 715.4 858.9 143.8 41.7 135.8 84.0 1,979.6

$ 5.2 142.5 50.6 88.3 54.7 247.9 589.2 970.4 127.1 48.4 260.7 87.5 2,083.3

Preferred stock Common stock Additional paid-in capital Retained earnings Accumulated other comprehensive income (loss) Treasury stock at cost Total shareholders’ equity attributable to Snap-on Inc. Noncontrolling interests Total shareholders’ equity Total liabilities and shareholders’ equity

– 67.4 225.1 2,324.1 (44.8) (458.6) 2,113.2 17.2 2,130.4 $ 4,110.0

– 67.4 204.6 2,067.0 (124.2) (412.7) 1,802.1 16.9 1,819.0 $ 3,902.3

Continued next page ©Cambridge Business Publishers, 2015 4-42

Financial & Managerial Accounting for MBAs, 4th Edition

continued Required: a. Compute net nonoperating expenses (NNE) for 2013 and 2012. Assume that combined federal and state statutory tax rate is 37% for both fiscal years. b. Compute net nonoperating obligations (NNO) for 2013 and 2012. c. Compute Spread for 2013 and 2012. Return on net operating assets is 14.5% and 14.3% in 2013 and 2012, respectively. In 2011, net nonoperating obligations were $798.5 million. d. Compute FLEV for 2013 and 2012. In 2011, net nonoperating obligations were $798.5 million and total shareholders’ equity was $1,547.3 million. e. Calculate return on equity (ROE) for both years. Show that ROE = RNOA + (FLEV × Spread) x NCI ratio. Interpret the year-over-year change in ROE. In 2011, shareholders’ equity attributable to Snap-On was $1,530.9. Hint: consider the changes in both FLEV and Spread) Answer: a. (Amounts in millions) Interest expense Other expenses (income) net Nonoperating expense, before tax Tax on nonoperating expense Nonoperating expenses, after tax (NNE) b.

(Amounts in millions) Notes payable and current maturities of long-term debt Long-term debt Less Nonoperating assets Net nonoperating obligations (NNO)

c.

Spread = RNOA – (NNE / Average NNO) 2013: 14.5% – $37.8 / [($754.4 + $761.1) / 2] = 14.5% – 5.0% = 9.5% 2012: 14.3% – $35.4 / [($761.1 + $798.5) / 2] = 14.3% – 4.5% = 9.8%

2013 $56.1 3.9 60.0 (22.2) $37.8

2012 $55.8 0.4 56.2 (20.8) $35.4

2013 $ 113.1 858.9 217.6 $754.4

2012 $ 5.2 970.4 214.5 $761.1

d. FLEV = Average NNO / Average shareholders’ equity 2013: [($754.4 + $761.1) / 2] / [($2,130.4 + $1,819.0) / 2] = 0.38 2012: [($761.1 + $798.5) / 2] / [($1,819.0 + $1,547.3) / 2] = 0.46 e. ROE = Net income attributable to Snap-on / Average Snap-on shareholders’ equity 2013: $350.3 / [($2,113.2 + $1,802.1) / 2] = 17.9% 2012: $306.1 / [($1,802.1 + $1,530.9) / 2] = 18.4% ROE = RNOA + (FLEV × Spread) x NCI ratio 2013: [14.5% + (0.38 × 9.5%)] x [(350.3/359.7) / (1,957.65/1,974.7)] = 17.8% (0.1% rounding difference) 2012: [14.3% + (0.46 × 9.8%) x [(306.1/314.6) / (1,666.5/1,683.15)] = 18.5% (0.1% rounding difference) The company’s ROE decreased during the year because spread decreased slightly from 9.8% to 9.5% and the financial leverage (FLEV) decreased from 0.46 to 0.38.

Test Bank, Module 4

©Cambridge Business Publishers, 2015 4-43

Topic: Use financial statements to compute ROE and disaggregate into operating and nonoperating components.

Note to instructor: FLEV is negative because Microsoft holds significant levels of marketable securities and has little debt; thus, ROE is less than RNOA. LO: 3 8. Income statements and balance sheets follow for Microsoft Corporation. Refer to these financial statements to answer the requirements.

Microsoft Corporation Income Statements Year ended June 30, 2013 2012 $ 77,849 $ 73,723 20,249 17,530 57,600 56,193 10,411 9,811 15,276 13,857 5,149 4,569 0 6,193 30,836 34,430 26,764 21,763

(in millions) Revenue Cost of revenue Gross profit Research and development Sales and marketing General and administrative Goodwill impairment Total operating expenses Operating income Other income Income before income taxes Provision for income taxes Net income

288 27,052 5,189 $ 21,863

504 22,267 5,289 $ 16,978

Microsoft Corporation Balance Sheets ($ millions) Cash and cash equivalents Short-term investments Accounts receivable, net Inventories Deferred income taxes Other current assets Total current assets

As of June 30, 2013 2012 $ 3,804 $ 6,938 73,218 56,102 17,486 15,780 1,938 1,137 1,632 2,035 3,388 3,092 101,466 85,084

Property plant and equipment, net Equity and other investments Goodwill Intangible assets, net Other long-term assets Total assets

9,991 10,844 14,655 3,083 2,392 $142,431

8,269 9,776 13,452 3,170 1,520 $121,271

Continued next page ©Cambridge Business Publishers, 2015 4-44

Financial & Managerial Accounting for MBAs, 4th Edition

continued icrosoft Corporation Balance Sheets (continued) ($ millions) Accounts payable Short-term debt Accrued compensation Income taxes Short-term unearned revenue Securities lending payable Other Current liabilities Long-term debt Long-term unearned revenue Deferred income taxes Other long-term liabilities Total liabilities

As of June 30, 2013 $ 4,828 2,999 4,117 592 20,639 645 3,597 37,417 12,601 1,760 1,709 10,000 63,487

Common stock and paid-in capital Retained earnings/(deficit) Accumulated other comprehensive income Total equity Total liabilities and equity

67,306 9,895 1,743 78,944 $142,431

2012 $ 4,175 1,231 3,875 789 18,653 814 3,151 32,688 10,713 1,406 1,893 8,208 54,908 65,797 (856) 1,422 66,363 $ 121,271

Required: a. Compute net nonoperating expenses (NNE) for 2013 and 2012. Assume that combined federal and state statutory tax rates are 37% for both years. b. Compute net nonoperating obligations (NNO) for 2013 and 2012. c. Compute Spread for 2013 and 2012. Return on net operating assets (RNOA) is 126.6% and 99.4% in 2013 and 2012, respectively. NNO were $(39,643) million in 2011. d. Compute FLEV for 2013 and 2012. In 2011, net nonoperating obligations (assets) were $(39,643) million and shareholders’ equity was $57,083 million. e. Calculate return on equity (ROE) for both years. Show that ROE = RNOA + (FLEV × Spread).

Interpret the year-over-year change in ROE.

Test Bank, Module 4

©Cambridge Business Publishers, 2015 4-45

Answer: a .

Other income

2013 288 107 (181)

2012 504 186 (318)

2013 2,999 645 12,601 (73,218) (3,804) $(60,777)

2012 $1,231 814 10,713 (56,102) (6,938) $(50,282)

Less Tax on nonoperating items (at 37%) Net nonoperating items after tax (NNE) b .

Short-term debt Securities lending payable Long-term debt Less Short-term investments Less Cash and cash equivalents Net nonoperating obligations c.

$

Spread = RNOA – (NNE / Average NNO) 2013: 126.6% – [$(181) / [(-$60,777 – $50,282) / 2]] = 126.6% – 0.3% = 126.3% 2012: 99.4% – [$(318) / [(-$50,282 – $39,643) / 2]] = 99.4% – 0.7% = 98.7%

d. FLEV = Average NNO / Average equity 2013: [(-$60,777 – $50,282) / 2] / [($78,944 + $66,363) / 2] = -0.76 2012: [(-$50,282 – $39,643) / 2] / [($66,363 + $57,083) / 2] = -0.73 e. ROE = Net income / Average equity 2013: $21,863 / [($78,944 + $66,363) / 2] = 30.1% 2012: $16,978 / [($66,363 + $57,083) / 2] = 27.5% ROE = RNOA + (FLEV × Spread) 2013: 126.6% + (-0.76 × 126.3%) = 30.6% (off 0.5% due to rounding) 2012: 99.4% + (-0.73 × 98.7%) = 27.3% (off 0.2% due to rounding) The company’s ROE increased during the year primarily because RNOA increased from 99.4% to 126.6%.

©Cambridge Business Publishers, 2015 4-46

Financial & Managerial Accounting for MBAs, 4th Edition

Topic: Use financial statements to calculate and interpret liquidity and solvency ratios LO: 4 9. Income statements and balance sheets follow for Snap-On Incorporated. Refer to these financial statements to answer the requirements.

Snap-On Incorporated Consolidated Statements of Earnings

Net sales Cost of goods sold Gross profit Operating expenses Operating earnings before financial services

For the fiscal year ended 2013 2012 $ 3,056.5 $ 2,937.9 (1,583.6) (1,547.9) 1,472.9 1,390.0 (1,012.4) (980.3) 460.5 409.7

Financial services revenue Financial services expenses Operating income from financial services Operating earnings Interest expense Other income (expense) -- net Earnings before income taxes and equity earnings Income tax expense Earnings before equity earnings Equity earnings, net of tax Net earnings Net earnings attributable to noncontrolling interests Net earnings attributable to Snap-on Incorporated

181.0 (55.3) 125.7 586.2 (56.1) (3.9) 526.2 (166.7) 359.5 0.2 359.7 (9.4) $ 350.3

(Amounts in millions)

161.3 (54.6) 106.7 516.4 (55.8) (0.4) 460.2 (148.2) 312.0 2.6 314.6 (8.5) $ 306.1

Continued next page

Test Bank, Module 4

©Cambridge Business Publishers, 2015 4-47

continued Snap-On Incorporated Consolidated Balance Sheets Fiscal Year End 2013

(Amounts in millions) Cash and cash equivalents Trade and other accounts receivable - net Finance receivables - net Contract receivables - net Inventories - net Deferred income tax assets Prepaid expenses and other assets Total current assets Property and equipment - net Deferred income tax assets Long-term finance receivables - net Long-term contract receivables - net Goodwill Other intangibles - net Other assets Total assets

$

217.6 531.6 374.6 68.4 434.4 85.4 84.2 1,796.2 392.5 57.1 560.6 217.1 838.8 190.5 57.2 $ 4,110.0

Notes payable and current maturities of long-term debt Accounts payable Accrued benefits Accrued compensation Franchisee deposits Other accrued liabilities Total current liabilities Long-term debt Deferred income tax liabilities Retiree health care benefits Pension liabilities Other long-term liabilities Total liabilities

$

113.1 155.6 48.1 95.5 59.4 243.7 715.4 858.9 143.8 41.7 135.8 84.0 1,979.6

$ 5.2 142.5 50.6 88.3 54.7 247.9 589.2 970.4 127.1 48.4 260.7 87.5 2,083.3

– 67.4 225.1 2,324.1 (44.8) (458.6) 2,113.2 17.2 2,130.4 $ 4,110.0

– 67.4 204.6 2,067.0 (124.2) (412.7) 1,802.1 16.9 1,819.0 $ 3,902.3

Preferred stock Common stock Additional paid-in capital Retained earnings Accumulated other comprehensive income (loss) Treasury stock at cost Total shareholders’ equity attributable to Snap-on Inc. Noncontrolling interests Total shareholders’ equity Total liabilities and shareholders’ equity

$

2012 214.5 497.9 323.1 62.7 404.2 81.8 84.8 1,669.0 375.2 110.4 494.6 194.4 807.4 187.2 64.1 $ 3,902.3

Continued next page ©Cambridge Business Publishers, 2015 4-48

Financial & Managerial Accounting for MBAs, 4th Edition

continued Required: a. Compute the company’s current ratio and quick ratio for fiscal 2013 and 2012. Comment on any observed trend. b. Compute the company’s times interest earned and liabilities-to-equity ratio for 2013 and 2012.

Comment on any observed trend. c. Summarize your findings in a conclusion about the company’s liquidity and solvency. Do you have any concerns about the company’s ability to meet its debt obligations?

Answer: a. Current ratio 2013: $1,796.2 / $715.4 = 2.51 2012: $1,669.0 / $589.2 = 2.83 The current ratio weakened during 2013, however, the company’s liquidity is very strong.

Quick ratio 2013: ($217.6 + 531.6 + 374.6 + 68.4) / $715.4 = 1.67 2012: ($214.5 + 497.9 + 323.1 + 62.7) / $589.2 = 1.86 Quick ratio weakened during 2013. The company has more quick assets, but current liabilities increased, thus, the ratio decreased. b. Times interest earned 2013: ($526.2 + $56.1) / $56.1 = 10.38 2012: ($460.2 + $55.8) / $55.8 = 9.25 The company more than covered fixed (interest) payments in both years. The 2013 ratio is larger, which implies the company’s solvency has improved during the year.

Liabilities-to-equity 2013: $1,979.6 / $2,130.4 = 0.93 2012: $2,083.3 / $1,819.0 = 1.15 The level of liabilities to equity decreased during 2013, thus the company is slightly less leveraged this year as compared to last year. c.

Overall, Snap-On seems to be quite liquid and solvent. We would want to compare these ratios to other manufacturers to make a more informed assessment. But, the ratios above are strong and there are no concerns about the company’s liquidity of solvency at this time.

Test Bank, Module 4

©Cambridge Business Publishers, 2015 4-49

Topic: Use financial statements to calculate and interpret liquidity and solvency ratios for two companies in the same industry LO: 4 10. Income statements and balance sheets follow for Microsoft Corporation and Apple Inc. Refer to these financial statements to answer the requirements.

Microsoft Corporation Income Statements Year ended June 30, 2013 2012 77,849 73,723 20,249 17,530 57,600 56,193 10,411 9,811 15,276 13,857 5,149 4,569 0 6,193 30,836 34,430 26,764 21,763 677 800 (429) (380) 40 84 27,052 22,267 5,189 5,289 21,863 16,978

(in millions) Revenue Cost of revenue Gross profit Research and development Sales and marketing General and administrative Goodwill impairment Total operating expenses Operating income Dividend and interest income Interest expense Other income, net Income before income taxes Provision for income taxes Net income

Microsoft Corporation Balance Sheets ($ millions) Cash and cash equivalents Short-term investments Accounts receivable, net Inventories Deferred income taxes Other current assets Total current assets

As of June 30, 2013 2012 $ 3,804 $ 6,938 73,218 56,102 17,486 15,780 1,938 1,137 1,632 2,035 3,388 3,092 101,466 85,084

Property plant and equipment, net Equity and other investments Goodwill Intangible assets, net Other long-term assets Total assets

9,991 10,844 14,655 3,083 2,392 $142,431

8,269 9,776 13,452 3,170 1,520 $121,271

Table continued next page

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table continued Microsoft Corporation Balance Sheets (continued) ($ millions) Accounts payable Short-term debt Accrued compensation Income taxes Short-term unearned revenue Securities lending payable Other Current liabilities Long-term debt Long-term unearned revenue Deferred income taxes Other long-term liabilities Total liabilities

As of June 30, 2013 $ 4,828 2,999 4,117 592 20,639 645 3,597 37,417 12,601 1,760 1,709 10,000 63,487

Common stock and paid-in capital Retained earnings/(deficit) Accumulated other comprehensive income Total equity Total liabilities and equity

67,306 9,895 1,743 78,944 $142,431

2012 $ 4,175 1,231 3,875 789 18,653 814 3,151 32,688 4,939 1,178 229 7,445 39,938 62,856 (16,681) 1,422 66,363 $ 121,271

Apple Inc. Consolidated Statement of Operations

(in millions) Net sales Cost of sales Gross margin Operating expenses Research and development Selling, general and administrative Total operating expenses Operating income Interest and dividend income Interest expense Other expense, net Income before provision for income taxes Provision for income taxes Net income

Fiscal year ended Sept. 28, 2013 Sept. 29, 2012 $ 156,508 $ 170,910 106,606 87,846 64,304 68,662 4,475 10,830 15,305 48,999 1,616 (136) (324) 50,155 13,118 $ 37,037

3,381 10,040 13,421 55,241 1,088 0 (566) 55,763 14,030 $ 41,733

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continued Apple Inc. Consolidated Balance Sheets (in thousands)

As of Sept. 28, 2013

Cash and cash equivalents Short-term investments Accounts receivable, net Inventories Deferred tax assets Vendor non-trade receivables Other current assets Total current assets Long-term marketable securities Property plant and equipment, net Goodwill, net Acquired intangible assets, net Other assets Total assets

$ 14,259 26,287 13,102 1,764 3,453 7,539 6,882 73,286 106,215 16,597 1,577 4,179 5,146 $ 207,000

$ 10,746 18,383 10,930 791 2,583 7,762 6,458 57,653 92,122 15,452 1,135 4,224 5,478 $ 176,064

Accounts payable Accrued expenses Deferred revenue Total current liabilities

$ 22,367 13,856 7,435 43,658

$ 21,175 11,414 5,923 38,542

2,625 16,960 20,208 83,451

2,648 0 16,664 57,854

19,764 104,256 (471) 123,549 $ 207,000

16,422 101,289 499 118,210 $ 176,064

Deferred revenue – non-current Long-term debt Other non-current liabilities Total liabilities Stockholders’ equity Common stock no par value Retained earnings Accumulated other comprehensive income (loss) Total stockholders’ equity Total liabilities and stockholders’ equity

Sept. 29, 2012

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Financial & Managerial Accounting for MBAs, 4th Edition

continued Required: a. Compute the current ratio and quick ratio for both firms for fiscal 2013. Compare the ratios and determine which company is more liquid. b. Compute the times interest earned and liabilities-to-equity ratios for both firms for fiscal 2013.

Which company is more solvent? c. Do you have any concerns about either company’s ability to meet its debt obligations? Explain.

Answer: a. Current ratio Microsoft: $101,466 / $37,417 = 2.71 Apple: $73,286 / $43,658 = 1.68 Quick ratio Microsoft: ($3,804 + $73,218 + $17,486) / $37,417 = 2.53 Apple: ($14,259 + $26,287 + $13,102) / $43,658 = 1.23 Microsoft is more liquid as both its current ratio and quick ratios exceed the Apple ratios.

However, ratios for both companies exceed 1.0, so both companies appear liquid. b. Times interest earned Microsoft: ($27,052 + $429) / $429 = 64.06 Apple: ($50,155 + $136) / $136 = 369.79 Liabilities-to-equity Microsoft: $63,487 / $78,944 = 0.80 Apple: $83,451 / $123,549= 0.68 Apple is more solvent than Microsoft, however both companies are highly solvent with very healthy times interest earned ratios and liabilities-to-equity ratios under the industry average of 1.5. c.

Both companies are very profitable and there are no concerns regarding either company’s ability to meet its debt obligations. Microsoft and Apple have cash available or can raise cash on short notice to meet its short-term debt obligations. Additionally, they are both extremely solvent with the ability to pay both periodic interest payments and repayment of long-term debt.

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Topic: Use financial statements to compute and interpret traditional DuPont ROE ratios.

LO: 5 11. Use the following balance sheets and income statements for Valero Energy Corporation to answer the requirements.

Valero Energy Corporation and Subsidiaries Consolidated Statements of Income (Millions of Dollars) Operating revenues Costs and expenses: Cost of sales Refining expenses Retail expenses Ethanol expenses General and administrative expenses Depreciation and amortization expense Asset impairment losses Total costs and expenses Operating income Gain on disposition of retained interest in CST Brands, Inc. Other income, net Interest and debt expense Income from continuing operations before income tax expense Income tax expense Net income (loss) Less: Net income (loss) attributable to noncontrolling interests Net income attributable to Valero Energy stockholders

2013 $138,074

2012 $ 139,250

127,316 3,704 226 387 758 1,720 0 134,111 3,963

127,268 3,668 686 332 698 1,574 1,014 135,240 4,010

325 59 (365)

0 9 (313)

3,982 1,254 2,728

3,706 1,626 2,080

8

(3)

$ 2,720

$

2,083

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Financial & Managerial Accounting for MBAs, 4th Edition

continued Valero Energy Corporation and Subsidiaries Consolidated Balance Sheets (Millions of Dollars) Cash and temporary cash investments Receivables, net Inventories Income taxes receivable Deferred income taxes Prepaid expenses and other Total current assets

2013 $ 4,292 8,751 5,758 72 266 138 19,277

2012 $ 1,723 8,167 5,973 169 274 154 16,460

Property, plant and equipment, net Intangible assets, net Deferred charges and other assets, net Total assets

25,707 156 2,120 $47,260

26,300 213 1,504 $44,477

$

$

Current portion of debt and capital lease obligations Accounts payable Accrued expenses Taxes other than income taxes Income taxes payable Deferred income taxes Total current liabilities Debt and capital lease obligations, less current portion Deferred income taxes Other long-term liabilities Total liabilities Common stock, $0.01 par value; 1,200,000,000 shares authorized; 627,501,593 and 627,501,593 shares issued Additional paid-in capital Treasury stock; 111,290,436 and 90,841,602 shares Retained earnings Accumulated other comprehensive income (loss) Total Valero Energy stockholders’ equity Noncontrolling interest Total equity Total liabilities and stockholders’ equity

303 9,931 522 1,345 773 249 13,123

586 9,348 590 1,026 1 378 11,929

6,261 6,601 1,329 27,314

6,463 5,860 2,130 26,382

7 7,187

7 7,322

(7,054) 18,970 350 19,460 486 19,946 $47,260

(6,437) 17,032 108 18,032 63 18,095 $44,477

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continued Required: a. Compute Valero’s return on equity (ROE) for 2013 and 2012. Valero Energy stockholders’ equity in 2011 was $16,423 million. b. Compute the profit margin (PM), asset turnover (AT), and financial leverage (FL) components of the basic DuPont model. Show that ROE = PM × AT × FL for 2013. Total assets were $42,783 million in 2011. Which component(s) explain the year over year change in Valero’s ROE? c. Compute adjusted return on assets (ROA) for 2013 and 2012. Assume a tax rate of 37% for both years.

Answers: a. ROE = Net income attributable to Valero / Average Valero stockholders’ equity 2013: $2,720 / [($19,460 + $18,032) / 2] = 14.5% 2012: $2,083 / [($18,032 + $16,423) / 2] = 12.1% b. PM = Net income / Revenue 2013: $2,720 / $138,074 = 2.0% 2012: $2,083 / $139,250 = 1.5% AT = Revenue / Average total assets 2013: $138,074 / [($47,260 + $44,477) / 2] = 3.01 2012: $139,250 / [($44,477 + $42,783) / 2] = 3.19 FL = Average total assets / Average stockholders’ equity 2013: [($47,260 + $44,477) / 2] / [($19,460 + $18,032) / 2] = 2.45 2012: [($44,477 + $42,783) / 2] / [($18,032 + $16,423/ 2] = 2.53 ROE = 2.0% × 3.01 × 2.45 = 14.7% (0.2% difference due to rounding) The increase in ROE in 2013, from 12.1% to 14.5%, was due to an increase in profit margin. c.

Adjusted ROA = (Net income + after tax interest expense) / Average total assets 2013: [$2,728 + ($365 × 63%)] / [($47,260 + $44,477) / 2] = 6.5% 2012: [$2,080 + ($313 × 63%)] / [($44,477 + $42,783) / 2] = 5.2%

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Financial & Managerial Accounting for MBAs, 4th Edition

Essay Questions Topic: Factors Limiting Usefulness of Ratio Analysis LO: 1 - 5 1. Discuss factors that limit the usefulness of financial accounting information for ratio analysis.

Answer: The first limitation arises from GAAP concepts such as non-measurable values, non-capitalized costs, and the irrelevance of historical costs. The second limitation arises when companies experience significant year over year changes. For example, a company may acquire or divest a subsidiary, thus throwing the numbers off. The final limitation is the impact of conglomerates. Most companies actually comprise several smaller companies. Taken as a whole, their combined numbers impair the ability to compare ratios with other competitors.

Topic: Conglomerates and Ratio Analysis LO: 1 - 5 2. Ratio analysis is more complicated when a company is a conglomerate. Why? Answer: Conglomerates are difficult to analyze because they are a blend of several businesses under one parent company. Since the different companies operating under the conglomerate may participate in a wide variety of industries, it is difficult to compare the conglomerate’s consolidated financial statements with its competitors.

Topic: Margin and Turnover LO: 2 3. Explain the trade-off between net operating profit margin and net operating asset turnover.

Answer: There are an infinite number of combinations of margin and turnover that yield a given RNOA. Typically companies with higher NOPM have lower NOAT. To attract investors, companies need to demonstrate an ability to earn an acceptable return on capital. Service companies can operate on a lower profit margin since they achieve a high turnover of net operating assets. Manufacturers, however, require higher profit margins in order to offset the lower asset turn.

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Topic: Disaggregation of ROE LO: 3 4. Explain how return on net operating assets (RNOA) and financial leverage (FLEV) affect Return on Equity (ROE). Is greater FLEV always better?

Answer: ROE is the return on equity and is the ultimate performance measurement from the investor’s standpoint. ROE is computed by taking a company’s net income attributable to controlling interests (less preferred dividends) and dividing by the stockholders equity attributable to controlling interests.

The ROE equation can also be disaggregated into RNOA + (FLEV × Spread) x NCI ratio. RNOA is the return on net operating assets and is a ratio of a company’s net operating profit after tax to net operating assets. RNOA measures the return on the company’s main operations, it shows how a company uses its operating capital and how much profit it is able to realize from these resources.

FLEV is a measure of a company’s leverage (how much debt the company uses compared to shareholders’ investment), and Spread measures the difference between the company’s operating return and the cost of debt. If the RNOA is higher than the cost of debt, leverage will increase a company’s overall profits.

Too much financial leverage can be risky. Debt is a contractual obligation that must be fulfilled regardless of the financial situation of the company. Therefore, creditors can force a company into bankruptcy and liquidate its assets, and this can cause shareholders to lose their entire investments.

The higher the amount of debt, the higher the risk of bankruptcy. Therefore, shareholders expect a higher rate of return which increases the minimum ROE for company survival. On the other hand, too little financial leverage results in shareholders’ equity not being optimally utilized, resulting in a lower stock price. When a firm first takes on debt the stock price increases, reflecting the positive benefits of low cost financing, as their interest rates will be low due to low amounts of debt. However, there is a point when the cost of the loan covenants, increased bankruptcy risk, and increased costs offset the positive effects of financial leverage. There is an optimal amount of financial debt to shareholder equity that will maximize the stock price and the ROE. Topic: Liquidity LO: 4 5. What is liquidity? Identify and discuss two ways to measure a company’s liquidity.

Answer: Liquidity is a term used to describe how much cash a company has at its disposal and how easily it can convert other assets to cash. Since most companies settle their obligations with cash, liquidity is a measure of how easily a company can fulfill its financial obligations and is necessary for survival.

There are several methods used to measure a company’s liquidity. One method is to calculate a company’s current ratio. The current ratio is the ratio of current assets to current liabilities and is a measure of working capital. Most companies prefer a current ratio greater than 1 as it is indicative of positive working capital. However, it is possible to have a liquid company and have a current ratio less than 1. For instance, cash and carry companies have significant operating cash inflows but very few current assets and, therefore, a low ratio. However, they are still liquid due to the large inflows of cash. Another example is companies that effectively manage their working capital by decreasing their inventories (current assets) and maximizing their accounts payable (current liabilities) by negotiating favorable credit terms. Although their current ratio is less than 1, they are liquid companies.

Another measure of liquidity is the quick ratio. The quick ratio focuses on specific current assets that can be converted to cash very quickly such as cash, marketable securities and accounts receivables, and it finds the ratio between these assets and the current liabilities. The quick ratio measures a company’s ability to fulfill its current liabilities without having to sell its inventories at a potentially lower price in order to quickly liquidate. Therefore, it is a stricter test of liquidity.

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Topic: Solvency LO: 4 6. What is solvency? Identify and discuss two ways a company’s solvency is measured.

Answer: Solvency measures a company’s ability to meet its financial commitments.

One of the most common measurements of solvency is the liabilities-to-equity ratio, which is the ratio of total liabilities to stockholders’ equity. The higher the liabilities-to-equity ratio, the larger the percentage of debt in a company’s structure, indicating a higher amount of financial leverage and greater risk. This ratio gives insight into how a company is financed. For instance, a high liabilities-toequity ratio indicates the company aggressively uses debt instead of financing the company with shareholders’ contributions. A lower liabilities-to-equity ratio indicates a conservatively managed and relatively stable company.

A second solvency metric is the times-interest-earned. This calculation takes into account how much profit is available to pay interest given the current level of debt and the repayment plan. Times interest earned is calculated as earnings before interest and taxes divided by interest expense. A high ratio is desirable as it indicates little chance of default on the loan agreements.

Topic: Traditional ROE (DuPont) analysis compared to RNOA analysis LO: 5 7. What is the difference between the traditional ROA measure (part of the traditional DuPont analysis) and the return on net operating assets (RNOA)?

Answer: The traditional ROA includes net income in the numerator and adjusts for interest expense. Thus, the ROA numerator includes all the profits (losses) from operating and nonoperating sources except for interest expense. The denominator (average total assets) includes all assets – this is different from the RNOA denominator in two ways. First, the ROA denominator it is not net of any liabilities, ROA includes only assets. In contrast, the denominator in RNOA is net of operating liabilities. Second, the ROA denominator includes all assets, both operating and nonoperating. The ROA measures total profit from all sources generated by all the resources (regardless of how the resources were financed) whereas RNOA measures operating profits generated from net operating assets. The two measures are useful but it is important to remember that they measure different things.

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