Financial Statement Analysis & Valuation 4e Easton McAnally
Sommers Zhan (Solutions Manual All Chapters, 100% Original
Verified, A+ Grade)
Module 1
Framework for Analysis & Valuation
DISCUSSION QUESTIONS
Superscript A denotes assignments based on Appendix 1A.
Q1-1. Organizations undertake planning activities that shape three major activities:
financing, investing, and operating. Financing is the means a company uses to pay
for resources. Investing refers to the buying and selling of resources necessary to
carry out the organization’s plans. Operating activities are the actual carrying out of
these plans. Planning is the glue that connects these activities, including the
organization’s ideas, goals and strategies. Financial accounting information provides
valuable input into the planning process, and, subsequently, reports on the results of
plans so that corrective action can be taken, if necessary.
Q1-2. An organization’s financing activities (liabilities and equity = sources of funds) pay for
investing activities (assets = uses of funds). An organization’s assets cannot be more
or less than its liabilities and equity combined. This means: assets = liabilities +
equity. This relation is called the accounting equation (sometimes called the balance
sheet equation), and it applies to all organizations at all times.
Q1-3. The four main financial statements are: income statement, balance sheet, statement
of stockholders’ equity, and statement of cash flows. The income statement provides
information about the company’s revenues, expenses and profitability over a period
of time. The balance sheet lists the company’s assets (what it owns), liabilities (what
it owes), and stockholders’ equity (the residual claims of its owners) as of a point in
time. The statement of stockholders’ equity reports on the changes to each
stockholders’ equity account during the period. The statement of cash flows identifies
the sources (inflows) and uses (outflows) of cash, that is, where the company got its
cash from and what it did with it. Together, the four statements provide a complete
picture of the financial condition of the company.
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Solutions Manual, Module 1 1-1
,Q1-4. The balance sheet provides information that helps users understand a company’s
resources (assets) and claims to those resources (liabilities and stockholders’ equity)
as of a given point in time.
Q1-5. The income statement covers a period of time. An income statement reports whether
the business has earned a net income (also called profit or earnings) or incurred a
net loss. Importantly, the income statement lists the types and amounts of revenues
and expenses making up net income or net loss.
Q1-6. The statement of cash flows reports on the cash inflows and outflows relating to a
company’s operating, investing, and financing activities over a period of time. The
sum of these three activities yields the net change in cash for the period. This
statement is a useful complement to the income statement, which reports on
revenues and expenses, but which conveys relatively little information about cash
flows.
Q1-7. Retained earnings (reported on the balance sheet) is increased each period by any
net income earned during the period (as reported in the income statement) and
decreased each period by the payment of dividends (as reported in the statement of
cash flows and the statement of stockholders’ equity). Transactions reflected on the
statement of cash flows link the previous period’s balance sheet to the current
period’s balance sheet. The ending cash balance appears on both the balance sheet
and the statement of cash flows.
Q1-8. External users and their uses of accounting information include: (a) lenders for
measuring the risk and return of loans; (b) shareholders for assessing the return and
risk in acquiring shares; and (c) analysts for assessing investment potential. Other
users are auditors, consultants, officers, directors for overseeing management,
employees for judging employment opportunities, regulators, unions, suppliers, and
appraisers.
Q1-9. Managers deal with a variety of information about their employers and customers
that is not generally available to the public. Ethical issues arise concerning the
possibility that managers might personally benefit by using confidential information.
There is also the possibility that their employers and/or customers might be harmed if
certain information is not kept confidential.
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1-2 Financial Statement Analysis & Valuation, 4h Edition
,Q1-10.A Procter & Gamble’s independent auditor is Deloitte & Touche LLP. The auditor
expressly states that “our responsibility is to express an opinion on these financial
statements based on our audits.” The auditor also states that “these financial
statements are the responsibility of the company’s management.” Thus, the auditor
does not assume responsibility for the financial statements.
Q1-11. Financial accounting information is frequently used in order to evaluate management
performance. The return on equity (ROE) and return on assets (ROA) provide useful
measures of financial performance as they combine elements from both the income
statement and the balance sheet. Financial accounting information is also frequently
used to monitor compliance with external contract terms. Banks often set limits on
such items as the amount of total liabilities in relation to stockholders’ equity or the
amount of dividends that a company may pay. Audited financial statements provide
information that can be used to monitor compliance with these limits (often called
covenants). Regulators and taxing authorities also utilize financial information to
monitor items of interest.
Q1-12. Managers are vitally concerned about disclosing proprietary information that might
benefit the company’s competitors. Of most concern, is the “cost” of losing some
competitive advantage. There traditionally has been tension between companies and
the financial professionals (especially investment analysts) who press firms for more
and more financial and nonfinancial information.
Q1-13. Net income is an important measure of financial performance. It indicates that the
market values the company’s products or services, that is, it is willing to pay a price
for the products or services enough to cover the costs to bring them to market and to
provide the company’s investors with a profit. Net income does not tell the whole
story, however. A company can always increase its net income with additional
investment in something as simple as a bank savings account. A more meaningful
measure of financial performance comes from measuring the level of net income
relative to the investment made. One investment measure is the balance of
stockholders’ equity, and the comparison of net income to average stockholders’
equity (ROE) is a fundamental measure of financial performance.
Q1-14. Borrowed money must be repaid, both the principal amount borrowed, as well as
interest on the borrowed funds. These payments have contractual due dates. If
payments are not prompt, creditors have powerful legal remedies, including forcing
the company into bankruptcy. Consequently, when comparing two companies with
the same return on equity, the one using less debt would generally be viewed as a
safer (less risky) investment.
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Solutions Manual, Module 1 1-3
, MINI EXERCISES
M1-15. (10 minutes)
($ millions)
Assets = Liabilities + Equity
$47,540 $36,839 $10,701
Dell receives more of its financing from nonowners ($36,839 million) than from owners ($10,701
million). Its owner financing comprises 22.5% of its total financing ($10,701 million / $47,540
million). Thus, nonowners finance 77.5% of Dell’s total assets.
M1-16. (10 minutes)
($ millions)
Assets = Liabilities + Equity
$16,787 $13,072 $3,715
Best Buy receives more of its financing from nonowners ($13,072 million) than from owners
($3,715 million). Its owner financing comprises 22.1% of its total financing ($3,715 million /
$16,787 million).
M1-17. (15 minutes)
($ millions)
Assets = Liabilities + Equity
Hewlett-Packard $108,768 $85,935 (a) $22,833
General Mills $ 22,658 (b) $14,562 $ 8,096
Target (c) $ 48,163 $31,605 $16,558
The percent of owner financing for each company follows:
Hewlett-Packard ......................... 21.0% ($22,833 million / $108,768 million)
General Mills .............................. 35.7% ($8,096 million / $ 22,658 million)
Target ........................................ 34.4% ($16,558 million / $ 48,163 million)
General Mills and Target are more owner financed, while Hewlett-Packard (HP) is more
nonowner financed. General Mills and Target are financed with roughly the same level of debt
and equity, while HP’s debt percentage is significantly higher than that of General Mills and
Target. All three enjoy relatively stable cash flows and can, therefore, utilize a greater proportion
of debt vs. equity. As the uncertainty of cash flows increases, companies generally substitute
equity for debt in order to reduce the magnitude of contractual payment obligations.
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1-4 Financial Statement Analysis & Valuation, 4h Edition
