Interpreting and analyzing financial statements 6th edition schoenebeck solutions manual 1

Across

4. Ratio measuring how expensive a company’s stock price is compared to EPS (2 words)

6. Shares bought back from investors

7. Solvency ratio that measures how debt boosts ROA to increase ROE (2 words)

10. If three-for-one, an investor holding 100 shares before holds 300 shares after (2 words)

11. Internal financing (2 words)

12. First time sale of stock to the public (3 words)

13. Statement reporting changes in shares outstanding, earnings, and the distribution of earnings (2 words)

15. Ratio measuring profitability from the shareholders’ perspective (3 words)

16. Maximum number of shares permitted to be issued

17. Ratio measuring the ability to pay periodic interest payments (3 words)

18. Legal value assigned to each share of stock; usually less than the market price of the stock (2 words)

19. Type of stock that all corporations must issue

Down

1. Shares sold to investors

2. Shares receiving dividends before common shares; usually carrying a dividend rate

3. Per share amount of dividends paid annually (2 words)

5. Amounts received in excess of par (4 words)

8. Amount of net income earned by each share of stock (3 words)

9. Total amount paid-in for shares of stock by investors (2 words)

14. Shares held by investors; issued shares less treasury shares

ACTIVITY 35 STATEMENT OF STOCKHOLDERS’ EQUITY TYPES OF STOCK

Purpose: • Identify three types of stock.

• Identify the number of shares authorized, issued, and outstanding.

• Compute the total cost of contributed capital and the average cost per share.

The Statement of Stockholders’ Equity provides information about changes in a company’s stockholders’ equity, including contributed capital and retained earnings. It helps investors understand the structure of a company’s ownership.

• Contributed capital (CC) includes amounts paid-in (contributed) by stockholders to purchase the stock of a corporation. There are two types of stock: common stock and preferred stock. Each corporation must issue common stock, whereas preferred stock is optional.

• When originally issued, amounts received from investors are recorded in two separate accounts the Par Value account and an Additional Paid-in-Capital account. Par Value is a legal value assigned to each share of stock upon incorporation, which must be recorded separately in the financial statements. Additional Paid-in-Capital (APIC) is the amount received in excess of par.

Par Value + Additional Paid-in-Capital = Total Issue Price of Stock

Refer to the Statement of Stockholders’ Equity for American Eagle Outfitters, Inc. and accompanying notes on page 107 to answer the following questions

Q1 For AEO the Par Value account is titled (Common Stock / Contributed Capital) and is $0.01 per share, while the Additional Paid-in-Capital account is titled (Common Stock / Contributed Capital).

Q2 On January 29, 2011 $2,496 thousand was reported as Common Stock (Par) and $546,597 thousand reported as Contributed Capital (APIC) for total contributions of $549,093 thousand for issued shares.

Q3 During FYE January 28, 2012, AEO repurchased common stock, which (increased / decreased) total stockholders’ equity by $17,349 thousand and reissued treasury stock which (increased / decreased) total stockholders’ equity by $6,549 thousand.

Upon incorporation, a company is authorized (by the state of incorporation) to issue a designated number of shares to investors. Sometimes corporations buy back shares of stock that have been issued; these are referred to as Treasury Stock Shares outstanding are the total number of shares actually held by investors at a given time, equaling shares issued less shares of treasury stock.

Sharesissued-Treasuryshares=Sharesoutstanding

Q4 On January 29, 2011 for preferred stock there are (0 / 5,000 / 600,000) thousand shares authorized, (0 / 5,000 / 600,000) thousand shares issued, and (0 / 5,000 / 600,000) thousand shares outstanding. Whereas for common stock on January 29, 2011 there are (600,000 / 249,566 / 194,366) thousand shares authorized, (600,000 / 249,566 / 194,366) thousand shares issued, and (600,000 / 249,566 / 194,366) thousand shares outstanding. [Refer to Note (1)]

Q5 On January 29, 2011 for common stock: 249,566 thousand shares issued – 55,200 thousand shares in treasury [Refer to Note (2)] = 194,366 thousand shares outstanding.

Q6 On January 29, 2011 there are 194,366 thousand shares of common stock issued for a total contribution of ($2,496 / $546,597 / $549,093 / $938,023) thousand, averaging ($3 / $17) per share. Also, there are 55,200 thousand shares of treasury stock with a total cost of ($2,496 / $546,597 / $549,093 / $938,023) thousand, averaging ($3 / $17) per share. Why does the average cost of issued common shares differ from the average cost of treasury shares?

AEO stock had its initial public offering (IPO) back on April 14, 1994, when the adjusted market price was less than $1 per share. Since then the stock climbed to a high of $32 per share in 2007, and in 2011 traded around $12-14 per share. Issued shares include stock issued during the IPO at the adjusted price of less than $1 per share, thus, the average market price of issued stock is only $3 share. Treasury stock was purchased more recently, reflecting the more recent and higher market price averaging $17 per share.

ACTIVITY 36 STATEMENT OF STOCKHOLDERS’ EQUITY

Purpose: • Interpret an increase and decrease in Stockholders’ Equity.

• Understand preferred and common stock dividends.

• Compute shares outstanding after a stock split.

Retained earnings (RE) are net income earned by the company since its incorporation and not yet distributed as dividends. It is increased by net income, the earnings of this accounting period, and decreased by dividends, a distribution of earnings.

Beginning Retained Earnings + Net Income - Dividends = Ending Retained Earnings

Refer to the Statement of Stockholders’ Equity for American Eagle Outfitters (AEO), Inc. and accompanying notes presented on page 107 to answer the following questions

Q1 For fiscal year ended on January 28, 2012 for AEO:

(January 29/ January 28), 2011

Q2 On January 28, 2012 stockholders’ equity totaled $1,416,851 thousand, which is the amount of business assets owned by shareholders.

Q3 Assume that AEO issued 1 million shares of preferred stock with a dividend rate of $5 per share.

a. Preferred shareholders would expect to receive $5 million in dividends each year.

b. (Preferred / Common) shareholders always receive their dividends first; this is part of the “preferred” treatment. Therefore, if the Board of Directors declared an $80 million dividend, preferred shareholders would receive $5 million in dividends and common shareholders would receive $75 million in dividends.

c. (Preferred / Common) stock usually has a stated dividend rate.

Q4 a. A company has 170 million common shares outstanding. Assume there is a two-for-one stock split, after the stock split there would be (113 / 170 / 255 / 340 / 510) million common shares outstanding. Assume there is a three-for-two stock split, after the stock split there would be (113 / 170 / 255 / 340 / 510) million common shares outstanding.

b. Because shareholders maintain the same proportionate share of a company’s wealth before and after a stock split, the stock split (increases / decreases / has no effect) on shareholder wealth.

c. Under International Financial Reporting Standards (IFRS), preferred stock would be classified as (a liability / stockholders’ equity) and the preferred dividend reported as (interest / dividends) on the income statement.

Q5 For each of the following events, identify the effect on stockholders’ equity.

a. Net income (increases / decreases / has no effect on) stockholders’ equity.

b. Cash dividends (increase / decrease / have no effect on) stockholders’ equity.

c. Repurchase of treasury stock (increases / decreases / has no effect on) stockholders’ equity.

d. Reissue of treasury stock (increases / decreases / has no effect on) stockholders’ equity.

Q6 (Common / Preferred / Treasury) stock is publicly traded, meaning the shares are bought and sold on public stock exchanges such as the New York Stock Exchange and NASDAQ.

ACTIVITY 37 RATIO ANALYSIS: EARNINGS

PER SHARE

Purpose: • Understand that EPS cannot be used to compare profitability among companies.

• Compute how treasury stock affects EPS.

• Identify EPS trends and compare EPS to Market Price to enhance meaning

Earnings per Share (EPS) indicates the amount of net income earnedbyeachindividualshareofstockheldbyinvestors.

EPS = Net income - Preferred dividends

Average number of common shares outstanding

Use the EPS information below for Athar and Wagdy Companies to answer the following questions.

Athar Company EPS = $0.50 Wagdy Company EPS = $2.00

Netincome = $1,000,000

Avg.#ofCSharesOS 2,000,000

Netincome = $1,000,000

Avg.#ofCSharesOS 500,000

Q1 Refer to the EPS information immediately above. Even though Wagdy Company reports (greater / lower) EPS, both companies have (the same / different) net income. A company with greater EPS (does / does not) indicate greater profitability.

Q2 If Athar Company buys back 1 million shares of common stock, then treasury stock would (increase / decrease), common shares outstanding would (increase / decrease), and EPS would (increase / decrease) to ($0.33 / $1 / $2) per share. The increase in EPS looks (good / bad) to shareholders because their proportionate ownership interest is (increased / decreased).

Alternatively, if Athar Company issues an additional 1 million shares of common stock then common shares outstanding would (increase / decrease) and EPS would (increase / decrease) to ($0.33 / $1 / $2) per share. The decrease in EPS looks (good / bad) to shareholders because their proportionate ownership interest is (increased / decreased). Athar

Q3 Refer to the EPS information immediately above. EPS for Athar Company has a/an (increasing / decreasing) trend, whereas Wagdy Company has a/an (increasing / decreasing) trend. EPS (can / cannot) be more meaningful when compared over time.

Athar Company EPS = $0.50 Wagdy Company EPS = $2.00

MarketPrice = $6/share =PERatio

EPS $0.50 of12

MarketPrice $60/share =PERatio

EPS $2.00 of30

Q4 Refer to the EPS and the Market Price information immediately above. The PE Ratio measures how expensive a stock is; how much investors are willing to pay for each $1 of EPS. A PE below 10 is considered a “bargain” stock, whereas a PE of more than 20 is considered “expensive.” Measured by the PE ratio, Athar Company stock is (a bargain / moderately-priced / expensive), while Wagdy Company stock is (a bargain / moderately-priced / expensive). EPS (can / cannot) be more meaningful when compared to market price per share.

Earnings per Share (EPS) indicates the amount of net income earnedbyeachindividualshareofstockheldbyinvestors.

Q1 Refer to the EPS information immediately above. Even though Wagdy Company reports (greater / lower) EPS, both companies have (the same / different) net income. A company with greater EPS (does / does not) indicate greater profitability.

Q2 If Athar Company buys back 1 million shares of common stock, then treasury stock would (increase / decrease), common shares outstanding would (increase / decrease), and EPS would (increase / decrease) to ($0.33 / $1 / $2) per share. The increase in EPS looks (good / bad) to shareholders because their proportionate ownership interest is (increased / decreased). Alternatively, if Athar Company issues an additional 1 million shares of common stock then common shares outstanding would (increase / decrease) and EPS would (increase / decrease) to ($0.33 / $1 / $2) per share. The decrease in EPS looks (good / bad) to shareholders because their proportionate ownership interest is (increased / decreased).

Q3 Refer to the EPS information immediately above. EPS for Athar Company has a/an (increasing / decreasing) trend, whereas Wagdy Company has a/an (increasing / decreasing) trend. EPS (can / cannot) be more meaningful when compared over time.

Q4 Refer to the EPS and the Market Price information immediately above. The PE Ratio measures how expensive a stock is; how much investors are willing to pay for each $1 of EPS. A PE below 10 is considered a “bargain” stock, whereas a PE of more than 20 is considered “expensive.” Measured by the PE ratio, Athar Company stock is (a bargain / moderately-priced / expensive), while Wagdy Company stock is (a bargain / moderately-priced / expensive). EPS (can / cannot) be more meaningful when compared to market price per share.

ACTIVITY 38 RATIO ANALYSIS: FINANCIAL LEVERAGE

Purpose: • Understand how debt affects financial leverage and ROE.

• Compute ROS, Asset Turnover, ROA, Financial Leverage, ROE, and the Debt Ratio.

Q1 Review Corporations A through E on page 113. All corporations have the same amount of (Sales revenue / Net income / Assets / Liabilities / Stockholders’ equity), but different amounts of (Sales revenue / Net income / Assets / Liabilities / Stockholders’ equity). Corp A has the (least / greatest) amount of liabilities, whereas Corp E has the (least / greatest) amount of liabilities.

Q2 Compute the ratios for Corp C, Corp D, and Corp E and record in the DuPont Analysis of ROE chart on page 116. As liabilities increase (ROS / Asset turnover / ROA / Financial leverage / ROE / Debt) ratios remain the same, but the (ROS / Asset turnover / ROA / Financial leverage / ROE / Debt) ratios increase.

Financial Leverage Ratio = Assets / SE

Because A = L + SE you can convert: Financial Leverage Ratio = 1 / (1 - Debt Ratio)

Q3 Corp D has a debt ratio of 75%, which results in Financial Leverage of (2 / 4 / 25), therefore, ROE is (2 / 4 / 25) times greater than ROA.

Corp A has no debt, therefore, ROA ( < / = / > ) ROE

Q4 Higher debt results in a (higher / lower) debt ratio, which leads to (higher / lower) Financial Leverage, which results in higher (ROA / ROE) because shareholders are assuming (higher / lower) risk.

Q5 In the Primary Driver chart on the previous page:

a. Circle the Primary Driver of ROA as either ROS or Asset Turnover.

b. Circle the Primary Driver of ROE as either ROA, Financial Leverage, or of equal (=) contribution.

Q6

a. The primary driver of ROA remains the same because (sales revenue / expenses / assets / liabilities) remain the same.

b. The primary driver of ROE changes because (sales revenue / expenses / assets / liabilities) change.

Q7 What is the primary driver of ROE when the debt ratio is:

a. Less than 50%? (ROA / = / LEV)

b. Equal to 50%? (ROA / = / LEV)

c. Greater than 50%? (ROA / = / LEV)

ANALYSIS of ROE

ACTIVITY 39 FINANCIAL LEVERAGE OF THREE COMPANIES

Purpose: • Understand how debt affects financial leverage and ROE.

• Compute Financial Leverage and ROE.

Refer to the financial information above for Yahoo! Inc. (YHOO), Costco Wholesale Corporation (COST), and Caterpillar Inc. (CAT) to answer the following questions.

Q1 Which company offers products to members in a range of merchandise categories that have been purchased directly from manufacturers? (YHOO / COST / CAT) The business strategy of this company is to purchase merchandise at (low / high) prices and then sell the merchandise to members at (low / high) prices to generate (low / high) volume. The (low / high) pricing strategy is reflected in (ROS / Asset Turnover / Financial Leverage) of 1.64%, whereas the (low / high) volume strategy is reflected in (ROS / Asset Turnover / Financial Leverage) of 3.32.

Q2 (ROS / ROA / ROE) is the most comprehensive profitability ratio, and of the three companies, (YHOO / COST / CAT) has the greatest profitability as measured by this ratio.

Q3 Compute Financial Leverage and ROE for Costco and Caterpillar and record in the chart above. (YHOO / COST / CAT) reports the greatest ROE and (YHOO / COST / CAT) is assuming the greatest amount of financial risk.

Q4 Costco has a debt ratio of approximately (15% / 55% / 84%), resulting in a Financial Leverage ratio of around (1 / 2 / 6); therefore, ROE is (1 / 2 / 6) times greater than ROA. Caterpillar has a debt ratio of approximately (15% / 55% / 84%), resulting in a Financial Leverage ratio of around (1 / 2 / 6); therefore, ROE is (1 / 2 / 6) times greater than ROA.

Q5 In the Primary Driver chart above:

a. Circle the Primary Driver of ROA as either ROS or Asset Turnover.

b. Circle the Primary Driver of ROE as either ROA, Financial Leverage, or of approximately equal (=) contribution.

Q6 Using only the financial information above, which company would you prefer to invest in? (YHOO / COST / CAT) Why?

Answers will vary, but should be supported by good reasoning. For example:

YHOO…offers the highest profitability reporting an ROA of 7.096%, reports the lowest financial risk (financial leverage of 1.1788), while still offering a modest return to shareholders of 8.36%.

COST…offers moderate profit, coupled with moderate financial risk reported by the financial leverage ratio of 2.23, which results in a moderate return to shareholders (ROE) of 12.18%.

CAT…offers a whopping 38.25% return to shareholders, but at the price of an 6.32 financial leverage ratio, indicating extremely high financial risk.

Purpose: • Review a number of ratios to better evaluate a company.

• Understand that the expected range of ratios varies by industry.

• Understand that comparing a ratio to industry norms enhances meaning Ratios reveal relationships.

Below are ratios with explanations introduced in this chapter. See Appendix B for additional ratios.

Financial Leverage is similar to the debt ratio, in the sense that the more debt a company has, the higher the Financial Leverage. It measures how debt “boosts” return on assets to increase return on equity.

Financial Leverage = Total assets

Stockholders’ equity

The Return on Equity (ROE) ratiomeasureshoweffectivelystockholders’equityisusedtoproduce netincome.ROAxFinancialLeverage=ROE

ROE = Net income

Stockholders’ equity

Times Interest Earned indicatesacompany’sabilitytoearn(cover)itsperiodicinterestpayments.

Times Interest Earned = Operating income Interest expense

Earnings per Share (EPS) istheamountofnetincome(loss)earnedbyeachindividualshareofstock heldbyinvestors.

EPS = Net income - Preferred dividends

Average number of common shares outstanding

The Dividend Rate istheamountofdividendspaidannuallyforeachshareofstockheldbyinvestors.

Dividend Rate = Annual common stock dividends paid

Average number of common shares outstanding

Investors use the Price Earnings (PE) ratio to measure how “expensive” a company’s stock is comparedtoEPS.Regrettably,itdoesnotexplainwhyastockisexpensiveorcheap.

PE Ratio = Market price per share EPS

Below are ratios and selected financial information for three companies within the Retail Apparel industry: American Eagle Outfitters, Inc. (AEO), GAP Inc. (GPS), and Urban Outfitters Inc.(URBN). RATIOS for the fiscal year ended January 29, 2011

* Industry Averages for Apparel Stores Industry and S&P 500 ratio averages from moneycentral.msn.com

** There are no official rules governing how these ratios are calculated. Therefore, the ratio formulas used may differ from the formulas in the text. For the fiscal year ended January 29, 2011

6e Statement of Stockholders’ Equity Page 120

Refer to the ratios and selected financial information for three companies within the Retail Apparel Industry: American Eagle Outfitters, Inc. (AEO), GAP Inc. (GPS), and Urban Outfitters Inc. on the previous page to answer the following questions

Q1 The strongest ROS ratio is reported by (AEO / GPS / URBN). ROS expresses net income as a percentage of (revenue / expenses / assets) and measures the firm’s ability to control (revenue / expenses / net income) to keep (revenue / expenses / net income) high.

Q2 Meaning is added to a ratio by comparing it to industry norms because success may vary by industry. An ROA ratio greater than the industry norm is reported by (AEO / GPS / URBN), indicating these companies have (greater / less) overall profitability than average within the Apparel Store Industry.

Q3 The greatest financial leverage ratio of 1.73 is reported by (AEO / GPS / URBN), which will boost ROA almost (1 / 2 / 4) times to increase (ROS / ROE / EPS / PE). The average Financial Leverage for the S&P 500 is (higher / lower) than the average for the Apparel Store Industry, indicating that the S&P 500 stocks carry (more / less) debt on average than the Apparel Store Industry.

Q4 The strongest ROE is reported by (AEO / GPS / URBN), with ROA contributing 17% to ROE and Financial Leverage contributing 12.5% to ROE. Therefore, (ROA / Financial Leverage) is the primary driver of ROE. (ROA 17% + Fin LEV 12.5% = ROE 29.5%)

Q5 A Times Interest Earned ratio greater than 4 generally indicates the ability to make interest payments. Companies within the Apparel Store Industry, on average, (have / don’t have) the ability to make interest payments

Q6 The higher EPS is reported by (AEO / URBN), indicating (AEO / URBN / can’t tell) is more profitable. EPS (does / does not) compare profitability among companies, but (does / does not) reflect shareholders’ proportionate share of earnings

Q7 The companies paying dividends are (AEO / GPS / URBN). AEO is paying out approximately (25% / 50% / 75%) of this year’s EPS. The dividend rate of AEO is (more / less) than the average for the S&P 500.

Q8 Urban Outfitter’s PE Ratio of 21 indicates there is $21 of market price for each $1 of EPS. As measured by the PE ratio, (AEO / GPS / URBN) stock is the most expensive. Using the PE ratio scale immediately above, AEO has (bargain-priced / moderately-priced / expensive) stock when compared to EPS. A higher PE ratio indicates (superior / inferior / can’t tell) stock.

Q9 Overall, which company has the greatest profitability? (AEO / GPS / URBN) How can you tell?

ROA is the most comprehensive measure of profitability. GPS reports an ROA of 17%, higher than the other two companies and twice the industry average.

Which company is assuming the greatest financial risk? (AEO / GPS / URBN) How can you tell?

The financial leverage ratio reflects the amount of financial risk with GPS reporting a ratio of 1.73, higher than the other two companies, but still below the industry norm.

Which company would you invest in? (AEO / GPS / URBN) Why?

Answers will vary, but should be supported by good reasoning. For example: AEO … pays dividends and is moderately priced compared to EPS.

GPS … reports the greatest profitability with an ROA of 17.04% and an ROE of 29.51%, both exceeding the industry average. Also, GPS pays dividends.

URBN … ROS, ROA, and ROE are all above the industry average while offering the lowest financial risk.

Purpose: • Identify reasons for change in cash, total liabilities, and stockholders’ equity

• Explain how changes in the balance sheet and income statement affect ROA and ROE

• Explain the effect of a huge cash dividend payment

Refer to the financial statement and ratio information for Microsoft on page 119 to answer the following questions.

Q1 Study the Statement of Stockholders’ Equity for the five years presented.

a. During fiscal year ended (FYE) 6/30/2003 stockholders’ equity increased primarily as a result of (net income / issuing common stock / repurchasing common stock / paying dividends).

b. During FYE 6/30/2004 stockholders’ equity (increased / decreased) primarily as a result of (net income / issuing common stock / repurchasing common stock / paying dividends).

c. During FYE 6/30/2005 stockholders’ equity (increased / decreased) primarily as a result of (net income / issuing common stock / repurchasing common stock / paying dividends).

d. During FYE 6/30/2006 stockholders’ equity (increased / decreased) primarily as a result of (net income / issuing common stock / repurchasing common stock / paying dividends).

e. During FYE 6/30/2007 stockholders’ equity (increased / decreased) primarily as a result of (net income / issuing common stock / repurchasing common stock / paying dividends).

Q2 Study the Balance Sheet for the five years presented.

a. During FYE 6/30/2005 cash equivalents (increased / decreased) significantly as a result of (a net loss / repurchasing common stock / paying dividends).

b. During FYE 6/30/2006 cash equivalents (increased / decreased) primarily as a result of (a net loss / repurchasing common stock / paying dividends).

c. From 6/30/2004 to 6/30/2007 total liabilities (increased / decreased) whereas stockholders’ equity (increased / decreased), resulting in a(n) (increasing / decreasing) debt ratio and (increasing / decreasing) financial leverage.

Q3 Study the Income Statement for the five years presented. From 6/30/2003 to 6/30/2007 revenues (increased / decreased), net income (increased / decreased), and EPS (increased / decreased).

Q4

a. During FYE (6-30-2004 / 6-30-2005 / 6-30-2006) Microsoft paid a huge special one-time $3 per share dividend totaling $36,968 billion. To pay this dividend, did Microsoft have enough cash? (Yes / No) Enough retained earnings? (Yes / No)

b. At this time Bill Gates owned 1.12 billion shares of Microsoft stock so his dividend was (1.12 / 2.24 / 3.36) billion dollars. What did Bill Gates do with his dividend? (Buy a super-duper sports car / Donate it to charity / Give it to his children)

Statement of Stockholders’ Equity

MICROSOFT STATEMENT OF STOCKHOLDERS' EQUITY Adapted

Q5 Review the DuPont Analysis of ROE for the five years presented.

a. Asset turnover = Sales revenue / Total assets

During FYE 6/30/2005 revenue (increased /decreased). The payment of this special dividend (increased /decreased) cash, which (increased /decreased) total assets, resulting in (increased /decreased) asset turnover.

b. ROA = ROS x Asset turnover. During FYE 6/30/2005 ROS (increased / decreased) and asset turnover (increased / decreased), resulting in ROA (decreasing / doubling / more than doubling).

c. Financial Leverage = SE / Total Assets. During FYE 6/30/2005 liabilities (increased /decreased), while SE (increased /decreased), which (increased /decreased) the debt ratio and (increased /decreased) financial leverage.

d. ROE = ROA x Financial Leverage. During FYE 6/30/2005 ROA (increased / decreased) and financial leverage (increased / decreased), resulting in ROE (decreasing / doubling / more than doubling).

Q6 What might have prompted this special one-time dividend?

First of all, MSFT had a huge hoard of cash, almost $50 billion on June 30, 2003, and shareholders were pressuring MSFT to do something with this cash. By mid-2004, the company had settled most of its legal issues relating to antitrust lawsuits that could have resulted in paying significant penalties, and so could now move forward and focus on a cash management plan. The cash management plan announced included a special $3 dividend to be paid December 2, 2004 and a stock buy-back program, together returning $75 billion in cash to shareholders over the next four years.

Q7 Review the financial information presented for Microsoft. Explain how the special one-time $3 dividend affected each of the following items.

a. Cash, Asset Turnover, and ROA

Paying cash dividends reduces cash, reducing total assets, which leads to an increase in asset turnover, which contributes to an increase in ROA.

Cash Total Assets Asset Turnover ROA

b. Debt Ratio, Financial Leverage, and ROE

Paying cash dividends reduces stockholders’ equity, indirectly increasing liabilities as a percentage of assets, which leads to a higher debt ratio, resulting in higher financial leverage, which contributes to an increase in ROE.

SE Debt Ratio Financial Leverage ROE

Q8 Cash is a (high / low) earning asset. Explain.

Historically, from 1928 to 2000, t-bills offered a mean return of 3.9% compared to a mean return of 12.7% by S&P 500 stocks, indicating that cash has a lower return, on average, than other investments.

Upon review of MSFT, you can see that ROA doubled from 6/30/2004 to 6/30/2005,and during that same period of time cash decreased from approximately $60 billion to $38 billion.

Q9 Review the financial information presented for Microsoft. Explain how the purchase of common stock (treasury stock) affected each of the following items.

a. Cash, Asset Turnover, and ROA

Purchasing treasury stock reduces cash, reducing total assets, which leads to an increase in asset turnover, which contributes to an increase in ROA.

Cash Total Assets Asset Turnover ROA

b. Debt Ratio, Financial Leverage, and ROE

Purchasing treasury stock reduces stockholders’ equity, indirectly increasing liabilities as a percentage of assets, which leads to a higher debt ratio, resulting in higher financial leverage, which contributes to an increase in ROE.

SE Debt Ratio

Financial Leverage ROE