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# E7-18 Direct method, P7-3 AR Turnover, P7-4 Credit P8-2 Tax

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EXERCISE 7-18: Cash Collections - Direct Method

Emily Enterprises' comparative balance sheets included accounts receivable of \$224,600 at December 31, 2011, and \$205,700 at December 31, 2012. Sales reported on Emily's 2012 income statement amounted to \$2.25 million. What is the amount of cash collections that Emily will report in the Operating Activities category of its 2012 statement of cash flows assuming that the direct method is used?

PROBLEM 7-3: Accounts Receivable Turnover for Coca-Cola and PepsiCo

The following information was summarized from the 2010 annual report of The Coca-Cola Company:
(in Millions)
Trade accounts receivable, less allowances of \$48 and \$55, respectively:
December 31, 2010 4430
December 31, 2009 3758
Net operating revenues for the year ended December 31:
2010 35119
2009 30990
The following information was summarized from the 2010 annual report of PepsiCo:
(in Millions)
Accounts and notes receivable, net
December 25, 2010 6323
December 26, 2009 4624
Net revenue for the year ended:
December 25, 2010 57838
December 26, 2009 43232

1. Calculate the accounts receivable turnover ratios for Coca-Cola and PepsiCo for 2010.
2. Calculate the average collection period, in days, for both companies for 2010. Comment on the reasonableness of the collection periods for these companies considering the nature of their business.
3. Which company appears to be performing better? What other information should you consider in determining how these companies are performing?

PROBLEM 7-4: Credit Card Sales

Gas stations sometimes sell gasoline at a lower price to customers who pay cash than to customers who use a credit card. A local gas station owner pays two percent of the sales price to the credit card company when customers pay with a credit card. The owner pays \$0.75 per gallon of gasoline and must earn at least \$0.25 per gallon of gross margin to stay competitive.

1. Determine the price the owner must charge credit card customers to maintain the station's gross margin.
2. How much discount could the owner offer to cash customers and still maintain the same gross margin?

Problem 8-2: Depreciation as a Tax Shield
The term tax shield refers to the amount of income tax saved by deducting depreciation for income tax purposes. Assume that Supreme Company is considering the purchase of an asset as of January 1, 2012. The cost of the asset with a five-year life and zero residual value is \$100,000. The company will use the straight-line method of depreciation.

Supreme's income for tax purposes before recording depreciation on the asset will be \$50,000 per year for the next five years. The corporation is currently in the 35% tax bracket.

Calculate the amount of income tax that Supreme must pay each year if the asset is not purchased. Calculate the amount of income tax that Supreme must pay each year if the asset is purchased. What is the amount of the depreciation tax shield?

PROBLEM 8-4: Depreciation and Cash Flow
O'Hare Company's only asset as of January 1, 2012, was a limousine. During 2012, only three transactions occurred: Services of \$100,000 were provided on account; All accounts receivable were collected; Depreciation on the limousine was \$15,000.

1. Develop an income statement for O'Hare Company for 2012.
2. Determine the amount of net cash flow for 2012.
3. Why does the net income not equal net cash flow?
4. If O'Hare developed a cash flow statement for 2012 using the indirect method, what amount would appear in the category titled Cash Flow from Operating Activities?

EXERCISE 9-5: Current Liabilities and Ratios

Several accounts that appeared on Kruse's 2012 balance sheet are as follows:
Accounts Payable \$55,000
Marketable Securities 40,000
Accounts Receivable 180,000
Notes Payable, 12%, due in 60 days 20,000
Capital Stock 1,150,000
Salaries Payable 10,000
Cash 15,000
Equipment 950,000
Taxes Payable 15,000
Retained Earnings 250,000
Inventory 85,000
Allowance for Doubtful Accounts 20,000
Land 600,000
1. Prepare the Current Liabilities section of Kruse's 2012 balance sheet.
2. Compute Kruse's working capital.
3. Compute Kruse's current ratio.

What does this ratio indicate about Kruse's condition?

EXERCISE 10-11: Impact of Transactions Involving Capital Leases on Statement of Cash Flows

Assume that Garnett Corporation signs a lease agreement with Duncan Company to lease a piece of equipment and determines that the lease should be treated as a capital lease. Garnett records a leased asset in the amount of \$53,400 and a lease obligation in the same amount on its balance sheet.

1. Indicate how this transaction would be reported on Garnett's statement of cash flows.
2. In the following list of transactions relating to this lease, identify each item as operating (O), investing (I), financing (F), or not separately reported on the statement of cash flows (N).

Reduction of lease obligating (principal portion of lease payment)
Interest expense
Increase in deferred taxes

PROBLEM 10-9: Partial Classified Balance Sheet for Walgreens

The following items, listed alphabetically, appear on Walgreen's consolidated balance sheet at August 31, 2010 (in millions).

Accrued expenses and other liabilities 2,763
Deferred income tax (long-term) 318
Long-term debt 2,389
Other noncurrent liabilities 1735
Short-term borrowing 12
Income Taxes 73

1. Prepare the Current Liabilities and Long-Term Liabilities sections of Walgreens's classified balance sheet at August 31, 2010.

2. Walgreens had total liabilities of \$10,766 and total shareholders' equity of \$14,376 at August 31, 2009. Total shareholders' equity at August 31, 2010, amounted to \$14,400. (All amounts are in millions.) Compute Walgreens's debt-to-equity ratio at August 31, 2010 and 2009.

As an investor, how would you react to the changes in the ratio?

3. What other related ratios would the company's lenders use to assess the company? What do these ratios measure? List as many as you determine needed.

PROBLEM 11-7: Wal-mart's Comprehensive Income

Following is the consolidated statement of shareholders' equity of Wal-Mart Stores, Inc., for the year ended January 31, 2010:
1. Which items were included in comprehensive income? If these items had been included on the income statement as part of net income, what would have been the effect?

2. Would the concept of comprehensive income help to explain to Wal-Mart's stockholders the impact of all events that took place in 2010? Why or why not?

Peeler Company was incorporated as a new business on January 1, 2012. The corporate charter approved on that date authorized the issuance of 1,000 shares of \$100 par, 7% cumulative, non-participating preferred stock and 10,000 shares of \$5 par common stock. On January 10, Peeler issued for cash 500 shares of preferred stock at \$120 per share and 4,000 shares of common stock at \$80 per share. On January 20, it issued 1,000 shares of common stock to acquire a building site at a time when the stock was selling for \$70 per share.

During 2012, Peeler established an employee benefit plan and acquired 500 shares of common stock at \$60 per share as treasury stock for that purpose. Later in 2012, it resold 100 shares of the stock at \$65 per share.

On December 31, 2012, Peeler determined its net income for the year to be \$40,000. The firm declared the annual cash dividend to preferred stockholders and a cash dividend of \$5 per share to the common stockholders. The dividends will be paid in 2013.

Indicate how each transaction affects the cash flow of Peeler Company by preparing the Financing Activities section of the 2012 statement of cash flows. Provide an explanation for the exclusion of any of these transactions from the Financing Activities section of the statement.

Cash flows from financing activities:
Transaction # Stock x Cost

The following transactions would not appear in the Financing Activities section of the statement of cash flows:

On its most recent statement of cash flows, a company reported net cash provided by operating activities of \$12 million. Its capital expenditures for the same year were \$2 million. A note to the financial statements indicated that the total amount of debt that would mature over the next five years was \$20 million.

1. Compute the company's cash flow adequacy ratio.
2. If you were a banker considering loaning money to this company, why would you be interested in knowing its cash flow adequacy ratio? Would you feel comfortable making a loan based on the ratio you computed in (1)? Explain your answer.

EXERCISE 12-20: Classification of Activities

Use the following legend to indicate how each transaction would be reported on the statement of cash flows. (Assume that the stocks and bonds of other companies are classified as long-term investments.)
II = Inflow from investing activities
OI = Outflow from investing activities
IF = Inflow from financing activities
OF = Outflow from financing activities
CE = Classified as a cash equivalent and included with cash for purposes of preparing the statement of cash flows

1. Purchased a six-month certificate of deposit
2. Purchased a 60-day Treasury bill
3. Issued 1,000 shares of common stock
4. Purchased 1,000 shares of stock in another company
5. Purchased 1,000 shares of its own stock to be held in the treasury
6. Invested \$1,000 in a money market fund
7. Sold 500 shares of stock to another company
8. Purchased 20-year bonds of another company
9. Issued 30-year bonds
10. Repaid a six-month bank loan

PROBLEM 13-6: Liquidity Analyses for Coca-Cola and Pepsi

The following information was summarized from the balance sheets of the Coca-Cola Company and Subsidiaries at December 31, 2010, and PepsiCo Inc. and Subsidiaries at December 25, 2010:
(in millions) Coca-Cola PepsiCo
Cash and cash equivalents \$8,517 \$5,943
Short-term investments 2,682 426
Marketable securities 138 -
Accounts and notes receivables, net* 4,430 6,323
Inventories 2,650 3,372
Prepaid expenses and other current assets 3,162 1,505
Total current assets \$21,579 \$17,569
Current liabilities \$18,508 \$15,892
*Described as "trade accounts receivable, less allowances" by Coca-Cola.

1. Using the information provided, compute the following for each company at the end of 2010:
Current ratio:
Quick ratio:

2. Coca-Cola reported cash flow from operations of \$9,532 million during 2010. PepsiCo reported cash flow from operations of \$8,448 million. Current liabilities reported by Coca-Cola at December 31, 2009, and PepsiCo at December 26, 2009, were \$13,721 million and \$8,756 million, respectively. Compute the cash flow from operations to current liabilities ratio for each company for 2010.
3. Comment briefly on the liquidity of each of these two companies. Which appears to be more liquid?
4. What other ratios would help you more fully assess the liquidity of these companies?

EXERCISE 13-8 Solvency Analyses for IBM

The following information was obtained from the comparative financial statements included in IBM's 2010 annual report. (All amounts are in millions of dollars).

12/31/2010 12/31/2009
Total liabilities \$90,279 \$86,267
Total stockholders' equity 23,172 22,755

For the Years Ended December 31
2010 2009
Interest expense \$368 \$402
Interest paid on debt 951 1,240
Provision for income taxes 4,890 4,713
Income taxes paid-net of refunds 3,238 1,567
Net income 14,833 13,425
Net cash provided by operating activities 19,549 20,773
Cash dividends paid 3,177 2,860
Payments for plant, rental machines and other property 4,185 3,447
Payments to settle debt 6,522 13,495

1. Using the information provided, compute the following for 2010 and 2009:
a. Debt-to-equity ratio
b. Times interest earned
c. Debt service coverage ratio
d. Cash flow from operations to capital expenditures ratio

2. Comment briefly on the company's solvency.

EXERCISE 13-11: Profitability Analysis for Carnival Corp.

Carnival Corporation and plc is one of the largest cruise companies in the world with such well-known brands as Carnival Cruise Lines, Holland America Line, and Princess Cruises. For the year ended November 30, 2010, the company reported net income of \$1,978 million. Total shareholders' equity on this date was \$23,031 million, and on November 30, 2009, it was \$22,039 million. No preferred stock was outstanding in either year.

1. Compute Carnival's return on common stockholders' equity for the year ended November 30, 2010.
2. What other ratio would you want to compute to decide whether Carnival is successfully employing leverage? Explain your answer.