Problems

Lawn Company Secrets

Lawn Company Secrets

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For additional practice, please see the problems (with selected solutions) provided on the Student CD-ROM that accompanies this book.

6.1 For each of the following, state whether the loss in value is due to use-related physical loss, time-related physical loss, or functional loss:

(a) -Albert sold his two-year-old computer for S500, but he paid S4000 for it new. It wasn't fast enough for the new software he wanted.

(b) Beatrice threw out her old tennis shoes because the soles had worn thin.

(c) Claudia threw out her old tennis shoes because she is jogging now instead.

(d) Day-old bread is sold at half-price at the neighbourhood bakery.

(e) Egbert sold his old lawnmower to his neighbour for £20.

(f) Fred picked up a used overcoat at the thrift store for less than 10% of the new price.

(g) Gunther notices that newspapers cost €0.50 on the day of purchase, but are worth less than €0.01 each as recyclable newsprint.

(h) Harold couldn't get the price he wanted for his house because the exterior paint was faded and flaking.

6.2 For each of the following, state whether the value is a market value, book value, scrap value, or salvage value:

(a) Inta can buy a new stove for S800 at Joe's Appliances.

(b) Jacques can sell his used stove to Inta for €200.

(c) Kitty can sell her used stove to the recyclers for S20.

(e) Xoriko is adding up the value of the things she owns. She figures her stove is worth at least ¥20 000.

6.3 A new industrial sewing machine costs in the range of S5000 to SlO 000. Technological change in sewing machines does not occur very quickly, nor is there much change in the functional requirements of a sewing machine. A machine can operate well for many years with proper care and maintenance. Discuss the different reasons for depreciation and which you think would be most appropriate for a sewing machine.

6.4 Communications network switches are changing dramaticallv in price and functionality as changes in technology occur in the communications industry. Prices drop frequently as more functionality and capacity are achieved. A switch only six months old will have depreciated since it was installed. Discuss the different reasons for depreciation and which you think would be most appropriate for this switch.

6.5 Ryan owns a five-hectare plot of land in the countryside. He has been planning to build a cottage on the site for some time, but has not been able to afford it yet. However, five years ago, he dug a pond to collect rainwater as a water supply for the cottage. It has never been used, and is beginning to fill in with plant life and garbage that has been dumped there. Ryan realizes that his investment in the pond has depreciated in value since he dug it. Discuss the different reasons for depreciation and which you think would be most appropriate for the pond.

6.6 A company that sells a particular type of web-indexing software has had two larger firms approach it for a possible buyout. The current value of the company, based on recent financial statements, is $4.5 million. The two bids were for S4 million and S7 million, respectively. Both bids were bona fide, meaning they were real offers. What is the market value of the company? What is its book value?

6.7 An asset costs $14 000 and has a scrap value of $3000 after seven years. Calculate its book value using straight-line depreciation

(a) After one year

(b) After four years

(c) After seven years

An asset costs $14 000. At a depreciation rate of 20%, calculate its book value using the declining-balance method

(a) After one year

(b) After four years

(c) After seven years

(a) An asset costs £14 000. What declining-balance depreciation rate would result in the scrap value of £3000 after seven years?

(b) Using the depreciation rate from part (a), what is the book value of the asset after four years?

Using a spreadsheet program, chart the book value of a $14 000 asset over a seven-year life using declining-balance depreciation (d = 0.2). On the same chart, show the book value of the S14 000 asset using straight-line depreciation with a scrap value of $3000 after seven years.

6.11 Using a spreadsheet program, chart the book value of a $150 000 asset for the first 10 years of its life at declining-balance depreciation rates of 5%, 20%, and 30%.

6.12 A machine has a life of 30 years, costs €245 000, and has a salvage value of €10 000 using straight-line depreciation. R^Tiat depreciation rate will result in the same book value for both the declining-balance and straight-line methods at the end of year 20?

A new press brake costs York $teel £780 000. It is expected to last 20 years, with a £60 000 salvage value. VTiat rate of depreciation for the declining-balance method will produce a book value after 20 years that equals the salvage value of the press?

(a) Using straight-line depreciation, what is the book value after four years for an asset costing $150 000 that has a salvage value of $25 000 after 10 years? What is the depreciation charge in the fifth year?

(b) Using declining-balance depreciation with d = 20%, what is the book value after four years for an asset costing $150 000? What is the depreciation charge in the fifth year?

(c) What is the depreciation rate using declining-balance for an asset costing $150 000 that has a salvage value of $25 000 after 10 years?

6.15 Julia must choose between two different designs for a safety7 enclosure, which will be in use indefinitely. Model A has a life of three years, a first cost of $8000, and maintenance of $1000 per year. Model B will last four years, has a first cost of $10 000, and has maintenance of $800 per year. A salvage value can be estimated for model A using a depreciation rate of 40% and declining-balance depreciation, while a salvage value for model B can be estimated using straight-line depreciation and the knowledge that after one year its salvage value will be $7500. Interest is at 14%. Using a present worth analysis, which design is better?

6.16 Adventure Airline's new baggage handling conveyor costs $250 000 and has a sendee life of 10 years. For the first six years, depreciation of the conveyor is calculated using the declining-balance method at the rate of 30%. During the last four years, the straight-line method is used for accounting purposes in order to have a book value of 0 at the end of the service life. What is the book value of the conveyor after 7, 8, 9, and 10 years?

6.17 Molly inherited $5000 and decided to start a lawn-mowing service. With her inheritance and a bank loan of $5000, she bought a used ride-on lawnmower and a used truck. For

6.10

6.13

6.14

five years, Molly had a gross income of S30 000, which covered the annual operating costs and the loan payment, both of which totalled S4500. She spent the rest of her income personally. At the end of five years, Molly found that her loan was paid off but the equipment was wearing out.

(a) If the equipment (lawnmower and truck) was depreciating at the rate of 50% according to the declining-balance method, what is its book value after five years?

(b) If Molly wanted to avoid being left with a worthless lawnmower and truck and with no money for renewing them at the end of five years, how much should she have saved annually toward the second set of used lawnmower and used truck of the same initial value as the first set? Assume that Molly's first lawnmower and truck could be sold at their book value. Use an interest rate of 7%.

6.18 Enrique is planning a trip around the world in three years. He will sell all of his possessions at that time to fund the trip. Two years ago, he bought a used car for €12 500. He observes that the market value for the car now is about €8300. He needs to know how much money his car will add to his stash for his trip when he sells it three years from now. Use the declining-balance depreciation method to tell him.

6.19 Ben is choosing between two different industrial frvers using an annual worth calculation. Fryer 1 has a five-year sendee life and a first cost of S400 000. It will generate net year-end savings of SI28 000 per year. Fryer 2 has an eight-year sendee life and a first cost of S600 000. It will generate net year-end savings of S135 000 per vear. If the salvage value is estimated using declining-balance depreciation with a 20% depreciation rate, and the MARR is 12%, which fryer should Ben buy?

6.20 Dick noticed that the book value of an asset he owned was exactly S500 higher if the value was calculated by straight-line depreciation over declining-balance depreciation, exactly halfway through the asset's sendee life, and the scrap value at the end of the senice life was the same by either method. If the scrap value was Si00, what was the purchase price of the asset?

6.21 A company had net sales of S20 000 last month. From the balance sheet at the end of last month, and an income statement for the month, you have determined that the current ratio was 2.0, the acid-test ratio was 1.2, and the inventor}7 turnover was two per month. W nat was the value of the company's current assets?

6.22 In the last quarter, the financial-analysis report for XYZ Company revealed that the current, quick, and equity ratios were 1.9, 0.8, and 0.37, respectively. In order to improve the firm's financial health based on these financial ratios, the following strategies are considered by XYZ for the current quarter:

(i) Reduce inventory

(ii) Pay back short-term loans

(iii) Increase retained earnings

(a) Which strategy (or strategies) is effective for improving each of the three financial ratios?

(b) If only one strategy is considered by XYZ, which one seems to be most effective? Assume no other information is available for analysis.

6.23 The end-of-quarter balance sheet for XYZ Company indicated that the current ratio was 1.8 and the equity ratio was 0.45. It also indicated that the long-term assets were twice as much as the current assets, and half of the current assets were highly liquid. The total equitv was S68 000. Since the current ratio was close to 2, XYZ feels that the company had a reasonable amount of liquidity in the last quarter. However, if XYZ wants more assurance, which financial ratio would provide further information? Using the information provided, compute the appropriate ratio and comment on XYZ's concern.

6.24 A potentially very large customer for Milano Metals wants to fully assess the financial health of the company in order to decide whether to commit to a long-term, highvolume relationship. You have been asked by the company president, Roch, to review the company's financial performance over the last three years and make a complete report to him. He will then select from your report information to present to the customer. Consequently, your report should be as thorough and honest as possible.

Research has revealed that in your industry (sheet metal products), the average value of the current ratio is 2.79, the equity ratio is 0.54, the inventory turnover is 4.9, and the net-profit ratio is 3.87. Beyond that information, you have access to only the balance sheet (on the next page) and the income statement shown here, and should make no further assumptions. Your report should be limited to the equivalent of about 300 words.

Milano Metals Income Statement for the Years Ending December 31, 2008, 2009, and 2010

(in thousands of dollars)

2008

2009

2010

Total revenue

9355

9961

8470

Less: Costs

8281

9632

7654

Net revenue

1074

329

816

Less:

Depreciation

447

431

398

Interest

412

334

426

Income taxes

117

21

156

Net income from operations

98

(457)

(164)

Add: Extraordinary item

770

(1832)

Net income

868

(457)

(1996)

6.25 The Milano Metals income statement and balance sheets shown for Problem 6.24 were in error. A piece of production equipment was sold for Si00 000 cash in 2010 and was not accounted for. V nich items on these statements must be changed, and (if known) by how much?

6.26 The Milano Metals income statement and balance sheet shown for Problem 6.24 were in error. An extra Si00 000 in sales was made in 2010 and not accounted for. Only half of the payments for these sales have been received. W nich items on these statements must be changed, and (if known) by how much?

6.27 At the end of last month, Paarl Alanufacturing had 45 954 rand (R45 954) in the bank. It owed the bank, because of the mortgage, R224 000. It also had a working capital loan of R30 000. Its customers owed R22 943, and it owed its suppliers R12 992. The company owned property worth R250 000. It had R123 000 in finished goods, R102 000 in raw materials, and R40 000 in work in progress. Its production equipment was worth R450 000 when new (partially paid for by a large government loan due to be paid back in three years) but had accumulated a total of R240 000 in depreciation, R34 000 worth last month.

Milano Metals

Consolidated Balance Sheets

December 31, 2008, 2009, and 2010

(in

thousands of

dollars)

Assets

2008

2009

2010

Current Assets

Cash

19

19

24

Accounts receivable

779

884

1176

Inventories

3563

3155

2722

4361

4058

3922

Fixed Assets

Land

1136

1064

243

Buildings and equipment

2386

4682

2801

3552

5746

3044

Other Assets

3413

3

Total Assets

8296

9804

6969

Liabilities and Owners' Equity

2008

2009

2010

Current Liabilities

Due to bank

1431

1 929

2040

Accounts payable

1644

1 349

455

Y\ ages payable

341

312

333

Income tax payable

562

362

147

Long-Tenn Debt

2338

4743

2528

Total Liabilities

6316

8695

5503

Owners" Equity

Capital stock

1194

1191

1091

Retained earnings

786

(82)

375

Total Owners' Equity

1980

1109

1466

Total Liability and Owners ' Equity

8296

9804

6969

The company has investors who put up R100 000 for their ownership. It has been reasonably profitable; this month the gross income from sales was R220 000, and the cost of the sales was only R40 000. Expenses were also relatively low; salaries were R45 000 last month, while the other expenses were depreciation, maintenance at R1500, advertising at R3400, and insurance at R300. In spite of R32 909 in accrued taxes (Paarl pays taxes at 55%), the company had retained earnings of R135 000.

Construct a balance sheet (as at the end of this month) and income statement (for this month) for Paarl Manufacturing. Should the company release some of its retained earnings through dividends at this time?

6.28 Salvador Industries bought land and built its plant 20 years ago. The depreciation on the building is calculated using the straight-line method, with a life of 30 years and a salvage value of $50 000. Land is not depreciated. The depreciation for the equipment, all of which was purchased at the same time the plant was constructed, is calculated using declining-balance at 20%. Salvador currently has two outstanding loans: one for S50 000 due December 31,2010, and another one for which the next payment is due in four years.

Salvador Industries

Balance Sheet as ofJune 30, 2010

Assets

Cash

S 350 000

Accounts receivable

2 820 000

Inventories

2 003 000

Prepaid services

160 000

Total Current Assets

I

Long-Term Assets

Building S200 000

Less accumulated depreciation

1 1

Equipment S480 000

Less accumulated depreciation 1 1

i 1

Land

540 000

Total Long-Term Assets

1 1

Total Assets

1

Liabilities and Owners' Equity

Current Liabilities

Accounts pavable

S 921 534

1

Accrued taxes

29 000

Total I 7 •

Long-Term Liabilities

Mortgage

SI 200 000

1 1

318 000

Total LonA-Term Liabilities

Total 1 1

Owners' Equity

Capital stock

SI 920 000

1 1

Total Owners' Equity

I 1

Total Liabilities and Owners' Equity 1

Total Liabilities and Owners' Equity 1

During April 2010, there was a flood in the building because a nearby river overflowed its banks after unusually heavy rain. Pumping out the water and cleaning up the basement and the first floor of the building took a week. Manufacturing was suspended during this period, and some inventory was damaged. Because of lack of adequate insurance, this unusual and unexpected event cost the company Si00 000 net.

(a) Fill in the blanks and complete a copy of the balance sheet and income statement here, using any of the above information you feel is necessary.

Salvador Industries Income Statement for the Year Ended June

30, 2010

Gross income from sales

S8 635 000

Less 1

I

7 490 000

1

1

Total income

1

1

Depreciation Interest paid Other expenses

70 000 240 000 100 000

Total expenses

I

Income before taxes

I

Taxes at 40%

1

1

1

Xet income

1

1

(b) Show how information from financial ratios can indicate whether Salvador Industries can manage an unusual and unexpected event such as the flood without threatening its existence as a viable business.

6.29 Movit Manufacturing has the following alphabetized income statement and balance sheet entries from the year 2010. Construct an income statement and a balance sheet from the information given.

Accounts payable

S 7500

Accounts receivable

15 000

Accrued wages

2850

Cash

2100

Common shares

150

Contributed capital

3000

Cost of goods sold

57 000

Current assets

Current liabilities

Deferred income taxes

2250

Depreciation expense

750

General expense

8100

GICs

450

Income taxes

1800

Interest expense

1500

Inventories

18 000

Land

3000

Less: Accumulated depreciation 10 950 Long-term assets

Long-term bonds 4350 Long-term liabilities

.Mortgage 9450

Net income after taxes 2700

Net income before taxes 4500

Net plant and equipment 7500

Net sales 76 500 Operating expenses Owners' equity

Prepaid expenses 450

Selling expenses 4650

Total assets 46 500

Total current assets 36 000

Total current liabilities 15 000

Total expenses 15 000

Total liabilities and owners' equity 46 500

Total long-term assets 10 500

Total long-term liabilities 16 050

Total owners'equity 15 450

Working capital loan 4650

6.30 Calculate for Movit Manufacturing in Problem 6.29 the financial ratios listed in the table below. Using these ratios and those provided for 2008 and 2009, conduct a short analysis of Movit's financial health.

Movit Manufacturing

Financial Ratios

Ratio

2010

2009

2008

Current ratio

1.90

1.60

Acid-test ratio

0.90

0.75

Equity ratio

0.40

0.55

Inventory-turnover ratio

7.00

12.00

Return-on-assets ratio

0.08

0.10

Return-on-equity ratio

0.20

0.18

1 Fraser Phraser operates a small publishing company. He is interested in getting a loan for expanding his computer systems. The bank has asked Phraser to supply them with his financial statements from the past two years. His statements appear below. Comment on Phraser's financial position with regard to the loan based on the results of financial ratio analysis.

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