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come more profitable by becoming more effective or efficient.

A.
SSP14-2
Caseopia Dragoon
2004 2003 2004 2003
Profit margin $100 $750 13.3% $87 $700 12.4% $37 $320 11.6% $46 $300 15.3%
Gross profit margin $300 $750 40.0% $280 $700 40.0% $112 $320 35.0% $120 $300 40.0%
Operating profit
margin $180 $750 24.0% $145 $700 20.7% $62 $320 19.4% $77 $300 25.7%
Asset turnover $750 $960 0.781 $700 $900 0.778 $320 $500 0.640 $300 $450 0.667
Accounts receivable
turnover $750 $46 16.304 $700 $43 16.279 $320 $23 13.913 $300 $20 15.000
Inventory turnover $450 $82 5.488 $420 $80 5.250 $208 $50 4.160 $180 $42 4.286
Return on assets $100 $960 10.4% $87 $900 9.7% $37 $500 7.4% $46 $450 10.2%



B. Dragoon’s return on assets was higher than Caseopia’s in 2000. During 2001,
Caseopia’s return on assets increased while Dragoon’s decreased, so that Caseopia’s re-
turn was higher in 2001. Several factors account for these changes. Dragoon’s profit
F548 SECTION F2: Analysis and Interpretation of Financial Accounting Information
553
Analysis of Operating Activities

margin decreased while Caseopia’s increased. This change was due to a decrease in
Dragoon’s gross profit margin and an increase in Caseopia’s operating profit margin.
Dragoon was less efficient in 2001 than in 2000 in controlling production costs, and
Caseopia was more efficient in controlling selling and administrative costs. Asset
turnover increased slightly for Caseopia and decreased slightly for Dragoon. Accounts
receivable turnover was lower in 2001 than in 2000 for Dragoon. Dragoon’s perfor-
mance was worse in 2001 than in 2000, primarily due to its lower profit margin.
Caseopia’s performance was better in 2001, primarily due to its higher profit margin.
Caseopia’s profit margin and asset turnover ratios were higher in 2001 than Dragoon’s,
indicating that it was the better-performing company.
Operating activities involve the production and sale of goods and services. Producing and sell-
SSP14-3
ing products requires investment in assets that are used in the production and selling processes.
As a company increases in size by investing in additional assets, it should be able to produce
and sell more products. Thus, revenues, expenses, and operating cash flows are affected by a
company’s assets. Assets are financed by debt and equity, including retained earnings. Con-
sequently, the more assets a company has, the more debt and equity it requires. The types of
financing a company uses affect its financial leverage. The types of assets it uses affect its op-
erating leverage. Increases in financial and operating leverage increase uncertainty about a
company’s future profitability. Therefore, operating, investing, and financing activities are
linked; one type of activity has a major effect on the other types of activities. Operating ac-
tivities cannot be evaluated separately from investing and financing activities. Relationships
among these activities are important for understanding a company’s past performance and
potential future performance.
A company’s accounting system provides information for understanding the company’s
financing, investing, and operating activities. This information has to be interpreted by deci-
sion makers. Interpretation depends on understanding how the information was created. For
example, accounting systems use measurement and reporting rules to determine what infor-
mation will be reported to decision makers and how activities will be measured. These rules
result in a particular presentation of a company’s activities; the presentation would be differ-
ent if other rules were used. Users should understand that accounting information, like any
information, provides only an approximation of the underlying company. Not all aspects of
a company are reported. Those that are reported are determined by the system. Therefore,
understanding the information and being able to use it effectively to make decisions requires
the decision maker to understand the biases and limitations of the information system.




Thinking Beyond the Question
How do operations create value for our business?


Companies use different strategies to earn profits. Successful use of these
strategies results in high return on the company’s investment and a high return
for its stockholders. A careful review of a company’s financial statements can
provide useful information for evaluating the company’s performance. Why is
accounting essential for good business decisions?




QUESTIONS
Sales at Tulip Manufacturing Company are expected to double during the coming year. The
Q14-1
company has unused capacity available and should be able to handle the new business. If a
Obj. 1
large portion of the company’s costs are fixed, what would you expect to happen to profits
during the coming year?
F549
CHAPTER F14: Analysis of Operating Activities
554 Analysis of Operating Activities

Q14-2 Sales at Borderline Insurance Agency are expected to double during the coming year. The com-
pany has been growing in recent years but generally has no trouble hiring more agents or leas-
Obj. 1
ing additional equipment when needed. If a large portion of the company’s costs are variable,
what would you expect to happen to profits during the coming year?
The sales manager at Buff & Tuff Health Machines has just completed a sales presentation to
Q14-3
staff indicating that the firm will, from now on, pursue a product differentiation strategy. He
Obj. 2
notes that this should have the effect of increasing the company’s asset turnover ratio with
only a minor decrease in its profit margin. Does the sales manager’s presentation make sense?
Why or why not?
Generic Chemical, Inc. produces standardized products that become raw materials for other
Q14-4
companies. One competitor’s goods are chemically identical to those of any other company.
Obj. 2
In general, would you expect this firm to have a high profit margin, high asset turnover, both,
or neither? Why?
Mystic Communications leads its industry in product innovation. Its financial success has been
Q14-5
the result of creating innovative products, getting them to market quickly, and building con-
Obj. 2
sumer acceptance. By the time competitors develop effective alternative products, Mystic has
moved on to other new products and markets. The cost of maintaining facilities to invent and
produce these products is high. Would you expect this company to have a high profit mar-
gin, high asset turnover, both, or neither? Why?
What are the primary differences between cost leadership and product differentiation?
Q14-6
Obj. 3

How are the cost leadership and product differentiation strategies used to improve return on
Q14-7
assets and profitability? In particular, how would you expect the choice of strategy to affect
Obj. 3
the components of return on assets reported by companies using these strategies?
A marketing manager in your company tells you, “We’ve got this great product—it’s really
Q14-8
special, much better than the competition’s. But we just can’t sell very much because our prices
Obj. 3
are so high. We’d make much more money if we lowered the prices.” Do you agree? Why or
why not? What other information would you want to have before making a final pricing de-
cision?
Q14-9 Under normal operating conditions, what relationship do you expect to find between net in-
come and net cash flow from operations? Which will be higher? Why? What will the major
Obj. 4
reconciling items be between the two?
Concerning net income and net cash flow from operations, will trends in one tend to be fol-
Q14-10
lowed by changes in the other? Explain. What trends might appear in a company with finan-
Obj. 4
cial problems?
The company you work for has a good return on assets, but inventory turnover and receiv-
Q14-11
ables turnover are low for your industry. You also have ongoing cash flow problems. Is there
Obj. 4
a connection? Explain the connection between inventory turnover, receivables turnover, and
the generation of cash flow from operations.
Why should the growth and variability of earnings affect the value of a company’s common
Q14-12
stock? Explain.
Obj. 5

Return on assets and return on equity are measures of performance. What is the difference
Q14-13
between the two measures? Be specific.
Obj. 5

Think about how the nature of financing, investing, and operating activities differ. What is
Q14-14
meant by “operating strategy”? How might one decide what strategy is most appropriate for
Obj. 5
a particular company?
F550 SECTION F2: Analysis and Interpretation of Financial Accounting Information
555
Analysis of Operating Activities

If your instructor is using Personal Trainer in this course, you may complete online the assign-
EXERCISES ments identified by .
Write a short definition of each of the terms listed in the Terms and Concepts Defined in this
E14-1
Chapter section.

You are preparing for a meeting at which your company will discuss its selling price for a new
E14-2
product. You have already made the decision to invest $2.3 million in production facilities
Obj. 1
with a capacity to produce 350,000 units per year. Fixed expenses, including depreciation and
minimal advertising, will be $300,000 per year. Variable expenses will be $4 per unit. Your
marketing people have developed three sales scenarios:
a. At a price of $7 per unit, below much of the competition, you sell 200,000 units per
year.
b. At a price of $9 per unit, the average among the competition, you sell 135,000 units per
year.
c. At a price of $7 per unit, with an additional $400,000 per year spent to advertise your
low price, you sell 300,000 units per year.
Prepare a schedule (according to the following format) that shows the pro forma (or expected)
profit from each scenario.

Strategy A Strategy B Strategy C
Unit price
Estimated sales in units
Sales revenue
Variable expenses
Fixed expenses
Additional advertising
Total expenses
Pro forma operating profit

Which scenario would you recommend? Why?

The Lakeside Symphony Association is a not-for-profit organization. The primary function of
E14-3
the association is to operate the Lakeside Symphony Orchestra for the benefit of local citizens.
Obj. 1
The board of directors of the organization is discussing ticket prices for the upcoming season.
Ticket receipts do not cover all costs of a concert; donations must be solicited for the re-
mainder, but finding enough donors is difficult, and funds are always scarce.
Each concert has fixed orchestra costs of approximately $28,000, primarily for paying the
musicians. The only variable costs are programs, tickets, and refreshments served at a reception
following the concert; these total about $2 per attendee. Orchestra managers estimate that they
can sell 1,300 tickets for the average concert at $12, 1,100 tickets at $15, or 800 tickets at $20.
Which option do you recommend? Why? Are the financial measurements used in this
chapter appropriate for a not-for-profit situation like this? Why or why not? What nonfinan-
cial considerations should enter into the decision?

Garden Company has the capacity to produce 200,000 tillers. Variable costs are $30 per tiller.
E14-4
Fixed costs are $1,500,000. Should the company aim to sell 200,000 at $100 each, 160,000 at
Obj. 1
$125 each, or 125,000 at $160 each? Explain your recommendation. What will the company
have to do to carry out the strategy you recommend?

Three companies have the following financial results:
E14-5
Obj. 2
Company A Company B Company C
Profit margin 0.05 0.40 0.25
Asset turnover 6.00 0.75 1.20
Return on assets 30% 30% 30%

What can you conclude about the financial results and the operating strategy of each com-
pany?
F551
CHAPTER F14: Analysis of Operating Activities
556 Analysis of Operating Activities

E14-6 Selected information from the annual report of Home Depot, Inc. is provided below. The re-
port is for the fiscal year ended February 3, 2002.
Objs. 2, 3

(In millions)
Net sales $53,553
Net income 3,044
Total assets 26,394

Calculate Home Depot’s profit margin, asset turnover, and return on assets. In comparison
with the companies shown in Exhibit 4 in this chapter, what strategy does Home Depot ap-
pear to be using to generate profits?

E14-7 Selected information from the 2001 annual reports of Hershey Foods Corp. and William
Wrigley Jr. Co. is provided below. Both companies are prominent in the sugar and confec-
Objs. 2, 3
tionary products industry.

(In millions) Hershey Foods Wrigley
Net sales $4,557 $2,430
Net income 207 363
Total assets 3,247 1,766

Compare the operating strategies of the two companies by calculating profit margin, asset
turnover, and return on assets. Which company appears to be doing the better job with its
strategy?

The numbers below are from the records of two small local restaurants.
E14-8
Objs. 2, 3
Pat’s Henry’s
Place Hangout
Sales $220,000 $190,000
Net income 80,000 30,000
Total assets 530,000 210,000

What do these numbers tell you about the operating strategy for each restaurant? What could
each do to improve its return on assets?

The numbers below are from the 2001 annual reports of two major airlines.
E14-9
Objs. 2, 3
Southwest Airlines Delta Air Lines
(In millions) 2001 2000 2001 2000
Sales $5,555 $5,650 $13,879 $16,741
Net income (loss) 511 603 (1,216) 828
Total assets 8,997 6,670 23,605 21,931

Calculate return on assets, asset turnover, and profit margin. Which airline appears to be more
successful? Do you find evidence of differences in operating strategies, or do both appear to
compete on the same basis? What could the less successful line do to improve profits?

Styles, Inc., a clothing manufacturer, reported the information given below over a three-year
E14-10
period.
Obj. 3

2005 2004 2003
Sales $ 9,000 $ 6,000 $3,000
Net income 1,683 852 288
Total assets 20,036 10,650 3,692
Inventory 1,500 960 500
Cost of goods sold 5,500 3,500 1,800
Fixed assets 4,000 2,500 1,500

(a) Compute the firm’s profit margin, asset turnover, day’s sales in inventory, fixed asset
turnover, and return on assets for each year shown. (b) Discuss the company’s operating strat-
egy over this time period.
F552 SECTION F2: Analysis and Interpretation of Financial Accounting Information
557
Analysis of Operating Activities

E14-11 Selected summary information is presented below for two companies.
Obj. 4
Fasani Thunderbird
Enterprises Corporation
(In millions) 2005 2004 2005 2004
Total assets $7,446 $6,512 $8,452 $7,786
Net sales 6,812 5,746 8,910 7,388
Net income 414 366 312 816
Depreciation and amortization 366 314 268 244
Decrease (increase) in receivables 12 (8) (326) (262)
Decrease (increase) in inventories 174 116 84 (32)
Increases (decrease) in payables 264 124 (114) (62)
Cash flow from operations $1,230 $ 912 $ 224 $ 704

a. Calculate the ratios of cash flow from operations to net income and to total assets.
b. Evaluate the success of each company at using assets to generate cash flow from opera-
tions.
c. What are the major causes of the difference between net income and cash flow for the
two companies?

Information is provided below from the 2002 annual report of the Walt Disney Company.
E14-12
Obj. 4
(In millions) 2002 2001 2000
Net earnings (loss) $ 1,236 $ (158) $ 920
Net cash from operating activities 2,286 3,048 3,755
Net cash from (for) investing activities (3,176) (2,015) (1,091)
Net cash from (for) financing activities 1,511 (1,257) (2,236)

(a) Evaluate Disney’s performance over the three years presented. Would you characterize the
company as growing, stable, or declining? (b) Is it surprising that the change in net earnings
differs from the change in net cash from operating activities over the period? Which measure
of operating activities is more stable? Why?

Information is provided below for Federated Department Stores, owner of several depart-
E14-13
ment store chains, including Bloomingdale’s, Macy’s, and The Broadway. The amounts given
Obj. 4
are from Federated’s annual report for the year ended February 2, 2002.

Fiscal Fiscal
(In millions) 2001 2000
Sales $15,651 $16,638
Cost of goods sold 9,584 9,955
Operating income 1,104 1,691
Net income (loss) (276) (184)
Accounts receivable 2,379 2,435
Merchandise inventories 3,376 3,626
Total assets 15,044 15,574
Cash provided by operating activities 1,372 1,332

Calculate inventory turnover, accounts receivable turnover, gross profit margin, and operat-
ing profit margin. Compare your results with those for Wal-Mart shown below. To what ex-
tent are the differences explained by the differing operating strategies of the two retailers?

Wal-Mart
(In millions) 2002 2001
Inventory turnover 7.6 7.0
Accounts receivable turnover 108.9 108.2
Gross profit margin 21.2% 21.4%
Operating profit margin 4.6% 5.0%
F553
CHAPTER F14: Analysis of Operating Activities
558 Analysis of Operating Activities

E14-14 Following is an income statement for Crystal Corporation.
Calculate three ratios that indicate efficiency and interpret the results.
Obj. 4



Crystal Corporation
Income Statement
For the Year Ending December 31, 2004

Sales revenue $50,000
Less: Cost of goods sold 25,000
Gross profit $25,000
Other operating expenses:
Advertising $3,000
Utilities 3,500
Wages 2,500 9,000
Operating income $16,000
Less: Income taxes 5,600
Net income $10,400



E14-15 Footpedal Enterprises has been in business for five years. This past year was the best year yet,
as demonstrated by several indicators shown below.
Obj. 4

2005 2004 2003 2002 2001
Inventory turnover 5.2 4.7 4.3 4.5 4.1
Accounts receivable turnover 6.0 5.7 5.4 5.4 5.3
Gross profit margin 23.2 22.8 22.9 22.6 21.8
Operating profit margin 12.1 12.0 11.9 11.8 11.9

Your new assistant wonders why upper management is so happy that the inventory turnover,
the accounts receivable turnover, the gross profit margin, and the operating profit margin all
increased this year. Explain why an increase in each of these items is a positive indicator.
The selected information below has been taken from the last two annual reports of Rasheed
E14-16
Company.
Obj. 4
2005 2004
Accounts receivable $ 1,466 $ 1,330
Merchandise inventory 2,093 1,947
Total assets 13,707 12,829
Total stockholders’ equity 4,386 4,180
Sales revenue 14,472 13,971
Cost of goods sold 11,481 11,606
Operating income 1,636 1,509
Net income 1,170 1,020
Interest expense 1,000 900
Fixed assets 8,000 7,500

a. Compute each of the following ratios for both years.
1. Inventory turnover
2. Accounts receivable turnover
3. Gross profit margin
4. Operating profit margin
5. Profit margin
6. Asset turnover
7. Return on assets
8. Return on equity
9. Times interest earned
10. Day’s sales in inventory
11. Average accounts receivable collection period
12. Fixed asset turnover (Continued)
F554 SECTION F2: Analysis and Interpretation of Financial Accounting Information
559
Analysis of Operating Activities

b. Has the company’s financial performance improved or deteriorated during the most re-
cent year? Was the firm more effective, more efficient, both, or neither? Which factors
contributed to the improvement? Did any factors hurt overall performance? Explain.
Your assistant has just provided you with your company’s latest financial results. Unfortunately,
E14-17
several of the numbers are smudged and unreadable. They are each represented below by a letter.
Obj. 4

Balance sheet (as of month-end) Income statement (as of month-end)
Cash $ 482 Sales revenue $10,377
Accounts receivable (a) Cost of goods sold 6,226
Merchandise inventory (b) Gross profit (f)
Buildings and equipment $3,411 Operating expenses:
Accumulated depreciation (922) Advertising $350
Investments, long-term 250 Depreciation 500
Land 980 Rent (g)
Total assets $ (c) Wages 376 (h)
Income before taxes $ 1,945
Accounts payable $ 977 Income taxes (35%) (i)
Notes payable, long-term (d) Net income $ (j)
Common stock 3,400
Retained earnings 1,491
Total liabilities and equity $ (e)
Summary ratio values
1. Accounts receivable turnover 5.62
2. Inventory turnover 7.15
3. Return on assets 18.27
4. Return on equity (k)

Determine the missing amounts above. (Round amounts to the nearest dollar.)
The following information was taken from the 2001 annual report of General Electric Com-
E14-18
pany (in billions).
Obj. 5
Net income $ 13.7
Interest expense 11.1
Total assets 495.0
Total stockholders’ equity 54.8

Calculate return on assets and return on equity. What conclusions can you draw about the ef-
fect of financial leverage on return to stockholders? Will financial leverage benefit stockhold-
ers under all conditions?
Bootstrap Computer Company reported the following summary information in its annual report.
E14-19
Obj. 5 2004
Sales $27,000
Net income 5,049
Total assets 60,108
Stockholders’ equity 40,070
Fixed assets 25,000
Income before interest & taxes 10,278
Interest expense 2,500
a. Compute each of the following ratios:
i. Profit margin
ii. Asset turnover
iii. Return on assets
iv. Return on equity
v. Fixed asset turnover
vi. Times interest earned
b. Explain how the return on equity measure includes information about all three activi-
ties in the transformation process.
F555
CHAPTER F14: Analysis of Operating Activities
560 Analysis of Operating Activities

E14-20 The following summary information is taken from the annual reports of McDonald’s Cor-
poration and Wendy’s International. All amounts are in millions.
Obj. 5



McDonald’s Wendy’s
2001 2000 2001 2000

Sales revenue $14,870 $14,243 $2,391 $2,237
Operating income 2,697 3,330 307 271
Net income 1,637 1,977 194 170
Total assets 22,535 21,684 2,076 1,958
Stockholders’ equity 9,488 9,204 1,030 1,126




a. Compute profit margin, asset turnover, return on assets, financial leverage, and return
on equity for both firms for both years.
b. Which company is more profitable? What similarities or differences do you observe in
how these two companies earned their profits during the periods shown?
Market to book value links company value to accounting numbers. It is related to a variety of
E14-21
attributes. Complete the table below by indicating whether the value of each attribute indicates
Objs. 5, 6
a high market to book value company or a low one. The first item is completed as an example.

Magnitude of Expected
Attribute Attribute Company Value
Asset growth High High
Debt to assets Low
Dividend payout Low
Equity growth Low
Investing cash outflow High
Operating cash inflow Low
Research and development expenditure High
Return on assets Low
Return on equity High
Sales growth High

Accounting reports provide a variety of information for evaluating a company. For each ac-
E14-22
counting number in the following list, write the letter from the description in the right-hand
Obj. 6
column that indicates the type of information provided by the number.

Description
Accounting Information
a. Ability to create value for stockholders from operating activities
__________ Asset turnover
b. Measures the effectiveness of a company in using its investment in
__________ Financial leverage
fixed assets to create sales
__________ Growth in assets
c. Ability to generate sales from total investment
__________ Growth in equity
d. Ability to generate profit from sales
__________ Growth in sales
e. Use of debt to increase return to stockholders
__________ Growth in return on equity
f. The ratio of operating income to interest expense
__________ Investing cash flow
g. Direction and amount of change in future return on equity
__________ Operating cash flow
h. Potential for higher return
__________ Profit margin
i. The ratio of accounts receivable to average daily sales
__________ Research and development
j. Reinvestment of earnings to increase value of company for stockholders
__________ Return on assets
k. Reinvestment of operating cash to increase value of company for
__________ Return on equity
stockholders
__________ Fixed asset turnover
l. Growth potential through innovation
__________ Times interest earned
m. Ability to create value from total investment
__________ Day’s sales in inventory
n. Source of cash for new investment and payments to stockholders
__________ Average accounts receivable
o. Ratio of inventory to average daily cost of goods sold
collection period
p. Potential for additional sales from increased investment
F556 SECTION F2: Analysis and Interpretation of Financial Accounting Information
561
Analysis of Operating Activities

E14-23 Following is the income statement and balance sheet of a company that just sold stock to the
public for the first time.
Obj. 6

Balance sheet at July 31, 2004 Income statement for July 2004
Cash $ 3,500 Sales revenue $5,000
Accounts receivable 2,000 Cost of sales 1,000
Inventory 1,700 Gross profit $4,000
Buildings, net 18,000 Operating expenses:
Wages $ 500
Total assets $25,200
Depreciation 400
Accounts payable $ 1,500 Interest 200
Wages payable 500 Operating income $2,900
Common stock 10,000 Income taxes 1,015
Retained earnings 13,200 Net income $1,885
Total liabilities and equity $25,200

The following terms are described under Objective 6 in this chapter. Find and list examples
of each of these concepts in the financial statements above.
a. Measurement units
b. Historical costs
c. Accrual basis
d. Fiscal periods
e. Matched
f. Estimation




If your instructor is using Personal Trainer in this course, you may complete online the assign-
PROBLEMS ments identified by .

Return Analysis
P14-1
Obj. 2 Information is provided below for three manufacturers from their 2001 annual reports.


Caterpillar, Inc.
(agricultural Kellogg Co. Eli Lilly & Co.
(In millions) machinery) (foods) (pharmaceuticals)

Net sales $20,450 $ 8,853 $11,543
Net income (loss) 805 474 2,780
Total assets 30,657 10,369 16,434
Total stockholders’ equity 5,611 872 7,104



Required
A. Calculate asset turnover, profit margin, return on assets, and return on equity for each
company.
B. Evaluate the relationship between asset turnover and profit margin and between return
on assets and return on equity for the companies.
F557
CHAPTER F14: Analysis of Operating Activities
562 Analysis of Operating Activities

P14-2 Evaluating Operating Strategies
Obj. 2
Information is presented below for two furniture companies.


(In thousands) Colony Vernon

Operating revenues $1,360 $1,440
Net income 180 130
Total assets 1,900 1,370
Fixed assets 1,400 1,000



Required
A. Compute profit margin, asset turnover, fixed asset turnover, and return on assets for
each company.
B. Compare the operating strategies of the two companies and explain which company is
doing the better job with its strategy.
C. Using the information presented, discuss how each company could improve its profits
and return on assets.

P14-3 Operating Strategy Decisions and Product Pricing
Objs. 1, 2, 3
You are working as an assistant to the vice president for marketing at Long Life Incorporated,
a startup manufacturer of a healthy, minimally refined breakfast cereal. Since little processing
will be done, much of the cost of the product will be in the premium ingredients. The com-
pany will be investing $3 million in processing and packaging facilities to produce a maxi-
mum of 15,000 cases of cereal per month. It will advertise and market only in a restricted
regional area in the foreseeable future, although expansion is possible in the long run. Fixed
costs for operating the facility will be approximately $85,000 per month. Variable costs, pri-
marily for ingredients and labor, are expected to be approximately $17 per case.
In the past, most cereals of this sort have been sold at specialty stores for high prices.
However, in recent years, some have moved into supermarkets at prices that are competitive
with those of traditional cereals. A marketing research study has given you estimated results
after the first year for three possible scenarios:
1. Sell to supermarkets for $29 per case, spend $25,000 per month on advertising, and sell
approximately 11,000 cases per month. The average price grocery stores pay competi-
tors for a case of this size is $30, and $25,000 is a minimal monthly budget for advertis-
ing in the local area.
2. Sell to supermarkets for $31 per case, spend $40,000 per month on advertising, and sell
approximately 12,000 cases per month.
3. Sell to specialty stores for $34 per case, spend only $7,000 per month advertising in
health food periodicals, and sell approximately 7,500 cases per month.

Required
A. Prepare a schedule (using the format on the next page) that shows the pro forma (or
expected) profit from each scenario.
B. Write a report for your company president and vice presidents in which you analyze
each of the above strategies and make a recommendation concerning which one to
choose.
C. Also include discussion of any long-term trends and other outside factors that you feel
should be considered in making this strategic decision.




(Continued)
F558 SECTION F2: Analysis and Interpretation of Financial Accounting Information
563
Analysis of Operating Activities

Strategy 1 Strategy 2 Strategy 3
Selling price per case
Estimated monthly sales (cases)
Sales revenue
Expenses:
Fixed, per month
Advertising, per month
Variable per case
Total monthly expenses
Pro forma monthly profit
Pro forma annual profit
% return on $3 million investment

Product Pricing Decisions
P14-4
Objs. 1, 3 You have been hired as a marketing manager for NuTech Appliance Company. The company
manufactures major home appliances, such as refrigerators, stoves, and dishwashers. NuTech
is about to add a new dishwasher to its lineup. The new appliance will have standard features,
appearance, and quality, except that it will be considerably quieter than similar models from
the competition.
The president of the company, Marta Feliz, has asked you to prepare a memo describing
the factors you believe the company should consider in pricing the new product.
Required Write a memo to Feliz. Describe the measurement or measurements you would
hope to maximize through a pricing decision. Then explain what factors should be consid-
ered, including information from within and outside of the company. Describe estimates that
you would want to develop before making a final pricing decision.

Assessing Operating Strategies
P14-5
Objs. 2, 3 Discount Shoes and Elegant Footwear are both retail shoe companies. Both have outlets in
major cities throughout the United States. Discount Shoes uses a cost leadership strategy, and
Elegant Footwear uses a product differentiation strategy.

Required Answer each of the following questions.
A. What differences would you expect to observe between the two companies with respect
to the location and design of their stores, the types of products they sell, and the types
of service they provide?
B. Compare the companies’ expected sales revenues, cost of goods sold, operating ex-
penses, merchandise inventory, and plant assets based on the strategies they use to gen-
erate profits.

Comparing Operating Strategies
P14-6
Objs. 2, 3 Companies’ operating strategies often result in differences in the following attributes: (a) types
of products, (b) sales price per unit, (c) profit margin, (d) asset turnover, and (e) amount in-
vested in assets.
Required Discuss the types of competitive strategies a company might use and how each
strategy would affect each of the attributes listed above. What factors are likely to affect the
strategy selected by a company?

Accrual- and Cash-Based Measurement of Success
P14-7
Objs. 2, 3, 4 The information below is extracted from the 2001 annual reports of three personal computer
companies.
Compaq Apple Dell
(In millions) 2001 2000 2001 2000 2001 2000
Sales $33,554 $42,222 $5,363 $7,983 $31,168 $31,888
Net income (loss) (785) 569 (25) 786 1,246 2,177
Total assets 23,689 24,856 6,021 6,803 13,535 13,670
Operating cash flow 1,482 565 185 868 3,797 4,195
F559
CHAPTER F14: Analysis of Operating Activities
564 Analysis of Operating Activities

Required Use appropriate analytical tools, including ratios, to answer the following questions.
A. Which company is most successful at generating net income from its assets?
B. Does this greater success result from the company using its assets more effectively to
generate sales or from its generating greater profit from its sales? How do the profit
margins compare?
C. Which company is most successful at generating cash flow from its assets?

Analyzing Cash Flow from Operations
P14-8
Obj. 4 Selected information is presented below for two companies that compete in the same industry.


Park Enterprises Schleifer, Inc.
2005 2004 2005 2004

Sales revenue $1,811 $1,476 $1,967 $2,212
Cost of goods sold 1,391 1,137 1,773 1,641
Ending accounts receivable 317 314 299 386
Ending inventory 115 216 132 355
From the statement of cash flows:
Net income $ 131 $ 79 $ (163) $ 85
Depreciation and amortization 29 21 31 25
(Increase) decrease in accounts
receivable (21) (86) 87 (70)
(Increase) decease in inventory 100 (14) 223 (137)
Increase (decrease) in accounts
payable and other current liabilities 121 62 (32) 55
Other items (19) 26 (41) (5)
Cash flow from operations $ 341 $ 88 $ 105 $ (47)




Required Using this information, examine the details of how each company generates cash
from operations.
A. Determine which company requires less time to convert inventory to sales. Consider
this in relation to gross profit margins.
B. Determine which company requires less time to collect its receivables from its cus-
tomers.
C. For each company and each year, examine and comment on the differences between
net income and cash flow from operations. What does this show you about the operat-
ing strengths or weaknesses of the companies?
F560 SECTION F2: Analysis and Interpretation of Financial Accounting Information
565
Analysis of Operating Activities

Evaluating Operating Performance
P14-9
Obj. 4 The following information was taken from the 2005 annual report of Hogar Products, Inc.
The company manufactures a wide variety of household products.

Year ended December 31 2005 2004 2003
(In millions, except per share data)
Net sales $3,720 $3,336 $2,973
Cost of products sold 2,548 2,260 2,020
Gross income $1,172 $1,076 $ 953
Selling, general, and administrative expenses 583 498 462
Trade names and goodwill amortization 55 32 24
Operating income $ 534 $ 546 $ 467
Nonoperating (income) expenses:
Interest expense 60 76 59
Other, net (211) (15) (18)
Income before taxes $ 685 $ 485 $ 426
Income taxes 289 192 169
Net income $ 396 $ 293 $ 257
Earnings per share:
Basic $2.44 $1.81 $1.60
Diluted $2.38 $1.80 $1.60

Required
A. How much did sales grow from 2003 to 2004 and from 2004 to 2005?
B. Restate each item on the income statement (except earnings per share) as a percent of net
sales. [Hint: Sales always 100%; 2005 cost of product sold 68.5% ($2,548 $3,720).]
C. What have the changes in relative revenues and expenses had on operating income and
net income over the three-year period?
D. What conclusions can you draw about the company’s operating leverage? Are most of
its costs fixed or variable?

Evaluating Operating Performance and Efficiency
P14-10
Obj. 4 Information is provided below for Coca-Cola Company and PepsiCo, Inc., for the years
1999–2001.
Coca-Cola PepsiCo
(In millions) 2001 2000 1999 2001 2000 1999
Net sales $20,092 $19,889 $19,284 $26,935 $25,479 $25,093
Gross profit 14,048 13,685 13,275 16,181 15,253 14,767
Operating profit 5,352 3,691 3,982 4,021 3,818 3,483
Net income 3,969 2,177 2,431 2,662 2,543 2,505

Required
A. Compute the three ratios that reflect operating efficiency.
B. Discuss the operating performance of Coca-Cola and PepsiCo using the information
you obtained in part A.

Evaluating Operating Performance and Effectiveness
P14-11
Obj. 4 Information is provided below for Coca-Cola Company and PepsiCo, Inc. for 2001 and 2000.

Coca-Cola PepsiCo
(In millions) 2001 2000 2001 2000
Net sales $20,092 $19,889 $26,935 $25,479
Cost of sales 6,044 6,204 10,754 10,226
Net income 3,969 2,177 2,662 2,543
Total assets 22,417 20,834 21,695 20,757
Accounts receivable, net 1,882 1,757 2,142 2,129
Inventories 1,055 1,066 1,310 1,192
Cash from operations 4,110 3,585 4,201 4,440
F561
CHAPTER F14: Analysis of Operating Activities
566 Analysis of Operating Activities

Required
A. Prepare a schedule showing the values of three turnover ratios for each company for
the two years shown.
B. Discuss the effectiveness of Coca-Cola and PepsiCo using the results of these turnover
ratios.
C. Using this information, discuss the cash operating performance of Coca-Cola and Pep-
siCo.

Analyzing Cash Flow from Operations
P14-12
Obj. 4 Information is provided below for Hasbro, Inc. and PepsiCo, Inc.

Hasbro PepsiCo
(In millions) 2001 2000 2001 2000
Net income $ 60 $ (145) $ 2,662 $ 2,543
Depreciation and amortization 226 264 1,082 1,093
Increase (decrease) from changes in
current assets and liabilities:
Accounts and notes receivable 99 396 7 (52)
Inventories 109 70 (75) (51)
Prepaid expenses and other current assets 46 (84) (6) (35)
Accounts payable, accrued liabilities,
and income taxes payable (195) (292) 158 554
Other adjustments 27 (46) 373 388
Cashflows from operations $ 372 $ 163 $ 4,201 $ 4,440

Total assets $3,369 $3,828 $21,695 $20,757
Accounts receivable and notes receivable, net 572 686 2,142 2,129
Inventories 217 335 1,310 1,192
Net sales 2,856 3,787 26,935 25,479
Cost of goods sold 1,223 1,674 10,754 10,226

Required
A. Compare the two companies as to their ratios of operating cash flow to total assets and
their ratios of operating cash flow to net income.
B. Compare the two companies as to their ability to convert revenues to cash.

Linking Operating, Investing, and Financing Activities
P14-13
Objs. 3, 4, 5 Information is provided below for Minnesota Mining and Manufacturing Corporation
(known as 3M) and Eastman Chemical Co. for 2001 and 2000.

3M Corp. Eastman Chemical
(In millions) 2001 2000 2001 2000
Net sales $16,079 $16,724 $5,390 $5,292
Net income (loss) 1,430 1,782 (175) 303
Total assets 14,606 14,522 6,092 6,550
Total stockholders’ equity 6,086 6,531 1,382 1,812

Required
A. Calculate profit margin, asset turnover, return on assets, financial leverage, and return
on equity.
B. Discuss the results and compare the companies’ effectiveness, efficiency, operating
strategy, use of investments in assets, and financing activity.

Comparing Results from Different Operating Strategies
P14-14
Objs. 3, 5 Big Bend, Inc. and Longbow, Ltd. have both been in the chemical business for several decades.
Each has developed a strong reputation in the industry and both are known for strong man-
agement. Big Bend tends to sell specialty products in small batches that are custom made.
(Continued)
F562 SECTION F2: Analysis and Interpretation of Financial Accounting Information
567
Analysis of Operating Activities

Longbow operates more in large-scale sales of commodity-type products that become raw ma-
terial for a wide variety of plastics and polymers. Selected information is presented below for
two recent fiscal periods.


Big Bend Longbow
(In millions) 2005 2004 2005 2004
Total assets $34.2 30.2 $ 38.2 36.1
Total stockholders’ equity 9.96 8.82 17.3 16.3
Sales revenue 40.3 35.9 206.5 193.3
Net income 3.68 3.13 6.4 5.8




Required
A. Considering only the brief written descriptions of the two firms, would you expect one
or the other to use a product differentiation strategy? Or cost leadership strategy? Ex-
plain.
B. Compute the profit margin, asset turnover, and return on assets for 2005 for both
firms. Are your expectations from part A borne out by the data for 2005?
C. What changes in profit margin, asset turnover, and return on assets have occurred be-
tween 2004 and 2005?
D. Compute the return on equity for both firms for both years.
E. Which is a more successful strategy, product differentiation or cost leadership? Explain.

Evaluating Growth and Value
P14-15
Obj. 5
Information is provided below from the 2002 annual reports of Sara Lee Corporation and
Dell Computer.

(In millions) 2002 2001 2000 1999 1998
Sara Lee
Total assets $13,753 $10,167 $11,611 $10,292 $10,784
Common stockholders’ equity 1,742 1,122 1,234 1,266 1,816
Sales 17,628 16,632 16,454 16,277 16,526
Dell
Total assets $13,535 $13,670 $11,471 $ 6,877 $ 4,268
Common stockholders’ equity 4,694 5,622 5,308 2,321 1,293
Sales 31,168 31,888 25,265 18,243 12,327

Required
A. Calculate the annual growth in assets, common equity, and sales for each company
from 1998 through 2002. (Hint: To compute the growth rate from year to year, use the
following formula—[(later year amount earlier year amount) earlier year
amount].)
B. Evaluate and compare the two companies’ growth rates. As an investor, would the dif-
ference in growth rates make one firm more attractive as an investment than the other?
Explain.
F563
CHAPTER F14: Analysis of Operating Activities
568 Analysis of Operating Activities

Connecting Operating Activities, Financing Activities, and Value
P14-16
Obj. 5 Billboards–R–Us and Outdoor SignCorp have the following selected information available.

2005 2004 2003 2002
Billboards–R–Us:
Total assets $12,431 $11,665 $10,862 $ 9,989
Stockholders’ equity 3,939 3,326 3,551 3,382
Net income (millions) 804 199 704 761
Diluted earnings per share 1.62 0.37 1.40 1.54
Market value per share 28.50 20.63 24.25 24.81
Total market value 13,680 9,902 11,761 11,810
Outdoor SignCorp:
Total assets $ 6,101 $ 5,533 $ 4,828 $ 4,077
Stockholders’ equity 2,246 1,816 1,390 1,528
Net income (millions) 740 694 331 644
Diluted earnings per share 5.48 5.17 2.45 4.78
Market value per share 97.13 77.00 67.50 69.13
Total market value 13,112 10,326 9,113 9,311

Required
A. Calculate the return on assets, return on equity, and market to book value for each year.
B. Evaluate the effects that operating activities and financing activities appear to have had
on the value of each company to its stockholders.
C. Has the stock price responded as you would expect? Explain.

Evaluating Operating Performance
P14-17
Obj. 5 Information is provided below for two companies that produce and sell audio-magnification
devices for the hearing impaired.

John, Inc. Roberta Company
2005 2004 2005 2004
Sales revenue 825 770 352 330
Cost of goods sold 540 504 250 216
Gross profit 285 266 102 114
Operating expenses 168 189 70 60
Operating income 117 77 32 54
Interest expense 30 20 10 8
Income before tax 87 57 22 46
Tax 30 20 8 16
Net income 57 37 14 30
Accounts receivable 78 73 39 34
Inventories 139 136 85 71
Fixed assets 900 850 600 550
Total assets 1,630 1,530 850 765

Required
A. For each company and each year, compute the following measures:
1. Profit margin
2. Gross profit margin
3. Operating profit margin
4. Asset turnover
5. Accounts receivable turnover
6. Inventory turnover
7. Return on assets
8. Fixed asset turnover
9. Times interest earned
10. Day’s sales in inventory
11. Average collection period for accounts receivable
(Continued)
F564 SECTION F2: Analysis and Interpretation of Financial Accounting Information
569
Analysis of Operating Activities

B. For each year, prepare a schedule summarizing which company had the better value of
each ratio.
C. Prepare a schedule that shows, for each company, whether the value of each ratio im-
proved or declined.
D. Which firm had the stronger operating performance during the periods studied? Briefly
summarize why.

Usefulness and Limitations of Financial Statement Information
P14-18
Obj. 6 You work as part of a team that selects parts suppliers for a large manufacturer. Your com-
pany is highly dependent on your suppliers, and you want long-term relationships. You want
suppliers who are financially stable, without cash flow problems. If they need more capacity
in order to grow with you, you want them to be able to attract additional investors.
One of your team members claims that financial statements tell you everything you need
to know to determine the future stability and growth potential of a supplier. Another claims
that financial statements are useless in the process, and that talking with the people in the
company is the only route to judging its future.

Required Discuss the strengths and weaknesses of financial statements in assisting you as
you try to determine the stability and growth potential of possible suppliers. What can you
learn about a company from a standard set of financial statements? What are the limitations
of financial statements? What would you look at in the statements to judge a supplier’s abil-
ity to remain in business and avoid cash flow problems? What relationships in the statements
would help you judge whether the company could attract additional capital for growth?

Value of Accounting and Auditing Standards
P14-19
Obj. 6 In the United States, the Financial Accounting Standards Board sets measurement and re-
porting standards for financial statements. For large companies, the Securities and Exchange
Commission imposes some additional standards. The Auditing Standards Board of the Amer-
ican Institute of CPAs determines standards for conducting an audit. Similar bodies perform
these functions in other countries. A major effort is being made to set worldwide standards.

Required Describe and evaluate these standards, answering the following questions.
A. What are measurement and reporting standards?
B. Why are measurement and reporting standards important to users of financial state-
ments?
C. What is an audit?
D. Why are auditing standards important to financial statement users?
E. What advantages and disadvantages do you see to having separate accounting and au-
diting standards for each country?

Excel in Action
P14-20
Accounting information is provided below for The Book Wermz and two of its competitors
for the fiscal year ending December 31, 2005.

The Book Wermz Book Farm Special Editions
Sales $6,230,000 $20,584,000 $4,896,200
Cost of goods sold 3,426,500 13,390,200 2,153,100
SPREADSHEET
Operating expense 2,155,000 5,212,600 1,852,000
Interest expense 190,000 670,500 106,000
Inventory 1,987,600 5,845,000 2,246,000
Total assets 5,623,000 13,254,000 6,895,000
Stockholders’ equity 3,370,000 6,687,000 4,826,000

Required Enter the data in a spreadsheet. Use the data to prepare an income statement for
each company to include gross profit, operating income, pretax income, and net income. The
income tax rate for each company is 35% of pretax income. Use formulas for computed val-
ues so that changes in any of the numbers shown above will be recomputed automatically in
the spreadsheet. Format the income statement appropriately.
F565
CHAPTER F14: Analysis of Operating Activities
570 Analysis of Operating Activities

Following the income statement, enter the balance sheet data for each company.
Use the income statement and balance sheet data to calculate the following ratios,
which should follow the balance sheet data: gross profit margin, operating profit margin,
profit margin, inventory turnover, asset turnover, return on assets, financial leverage (as-
sets/equity), and return on equity. The calculations should use cell references to the in-
come statement and balance sheet data. Each ratio should include four digits to the right
of the decimal.
Following the ratios, provide a brief response to the following questions.
1. Which company appears to be using a cost leadership strategy most effectively?
2. Which company appears to be using a product differentiation strategy most effec-
tively?
3. What strategy does The Book Wermz appear to be following and how effective has this
strategy been?
4. What effect has financial leverage had on the companies’ ratios?
Format each response so that it appears as wrapped text in a cell that is the width of the
columns used to enter data in the spreadsheet.
Include the following captions at the top of the spreadsheet: “Financial Analysis Com-
parison”, followed by “December 31, 2005”. Captions should be centered over the spreadsheet
columns in which accounting information appears.

Multiple-Choice Overview of the Chapter
P14-21
1. If a company sets its product price too high, the primary danger is that
a. asset turnover will be too low.
b. gross profit margin will be too low.
c. inventory turnover will be too high.
d. accounts receivable turnover will be reduced.
2. A company’s profit margin is the ratio of its earnings to its
a. total assets.
b. total liabilities.
c. operating income.
d. operating revenues.
3. A company that follows a product differentiation strategy tends to have
a. high profit margin and asset turnover.
b. low profit margin and asset turnover.
c. high profit margin and low asset turnover.
d. low profit margin and high asset turnover.
4. Chrysanthemum Company reported a profit margin of 5% and an asset turnover of 2.0
for the fiscal year. The company’s return on assets for the year was
a. 10%.
b. 3%.
c. 2.5%.
d. 2%.
5. Which company is likely to have the lowest ratio of cash flow from operations to net
income?
a. A shrinking company that is reducing inventory and receivables
b. A growing company with increasing inventory and receivables
c. A company with new, expensive assets and high depreciation charges
d. A company with a growing deferred tax liability
6. High receivables turnover is evidence of
a. extension of credit to customers who are poor credit risks.
b. high sales volume.
c. low efficiency.
d. rapid collection of cash from customers.

(Continued)
F566 SECTION F2: Analysis and Interpretation of Financial Accounting Information
571
Analysis of Operating Activities

7. A tendency to sell products rapidly is evidenced by
a. low asset turnover.
b. high inventory turnover.
c. high operating leverage.
d. a cost leadership operating strategy.
8. Which of the following is the strongest indicator of a high-value company?
a. High market to book value
b. High gross profit margin
c. High financial leverage
d. High ratio of operating cash flow to net income
9. The difference between a company’s return on assets and its return on equity can be
explained by the company’s
a. operating leverage.
b. asset turnover.
c. financial leverage.
d. profit margin.
10. Accounting can best be defined as
a. a precise reporting system for giving decision makers a total picture of all events oc-
curring in a business entity.
b. an information system for measuring the transformation process in a business entity
and reporting results to decision makers.
c. a procedure for recording the transactions of a business entity, usually using a sys-
tem of debits and credits.
d. a set of rules, developed by standard-setting bodies, for measuring and reporting.




Projects
CASES
Analysis of Operating Activities
C14-1
Objs. 3, 4, 5 Appendix B of this book contains a copy of the 2002 annual report of General Mills, Inc.

Required Review the annual report and answer each question or follow the directions given.
A. Compute profit margin, asset turnover, and return on assets for the company for 2000
to 2002. Evaluate the changes you see in these measures over the three years. (Hint: See
also the six-year financial summary shown in the annual report for the data necessary
to make some of your calculations.)
B. Compare your ratio calculations with those in Exhibit 4. Based on this and any other
evidence contained in the annual report, does it appear that General Mills is using a
cost leadership strategy or a product differentiation strategy?
C. Compute receivables turnover, inventory turnover, and gross profit margin for 2002
and 2001. Evaluate any changes you find.
D. Compute the return on equity for each of the three years and compare it with the re-
turn on assets. Do the changes in return on equity result more from changes in net in-
come or from changes in the amount of stockholders’ equity?
E. Financial statements present only a partial, highly summarized view of a company. As-
sume that you are considering investing in General Mills’ common stock. List several
items that are contained in the statements but are based on estimates. Also list several
items you would like to know about the company that are not revealed in this annual
report.

Analysis of an Investment
C14-2
Objs. 4, 5 You are an investment analyst. Some of your clients have talked with you about an invest-
ment they are considering in a new company, Beach Front Resorts. This company will con-
struct condominiums and rent them to tourists. The total investment required for the project
is $5.5 million. Individual investors are expected to invest not less than $100,000 each. They
F567
CHAPTER F14: Analysis of Operating Activities
572 Analysis of Operating Activities

could borrow up to this amount at 10% annual interest. The development will contain 50
units that will cost $80,000 per unit to construct. Land for the development will cost $250,000,
and $300,000 will be held in reserve for first-year operating costs for the year beginning Jan-
uary 1, 2004. The remaining investment capital will be used for furnishings, streets, parking
lots, sidewalks, and landscaping. Buildings will be depreciated over a 20-year period. Other
depreciable assets will be depreciated over five years. Straight-line depreciation will be used.
Based on an analysis of similar developments in the area, units should rent for an aver-
age of $1,300 per week. Each unit should rent for at least 25 weeks per year. On the average,
each unit is expected to rent for 30 weeks per year. Maintenance and operating costs are ex-
pected to average $200 per unit-week for 52 weeks. Management costs will be $250,000 per
year. A reserve fund will be established with annual reinvestments of profits of $200,000 for
future repair and replacement of property. The remaining profits will be distributed to in-
vestors in proportion to their investments. The company is not subject to income tax.

Required
A. Calculate the net income and cash flow to investors from operating activities expected
from the project in 2004, assuming average rentals of 25 and 30 weeks. Assume that
cash flows are equivalent to revenues and expenses except for depreciation. Which is
more relevant to the investment decision, net income or cash flow? Why?
B. Assume that investors could expect to receive net cash flows from their investments for
10 years at the amounts expected for 2004. At the end of 10 years, they expect to be
able to sell their investments for $1.2 million. What is the present value of the cash
flows, assuming 25-week and 30-week average rentals each year? The expected rate of
return is 10%.
C. What effect does the company’s operating leverage have on its expected operating re-
sults?
D. Would you recommend that your clients invest in Beach Front Resorts? What factors
are important to this decision other than those considered above?

Making an Investment Decision
C14-3
Objs. 4, 5 A friend has given you a hot tip on an investment opportunity in a business venture. You
would have to invest $20,000 in the business for a 10% ownership share. The business would
import goods from South America and sell them in several large cities in the United States.
The total investment in the company will be $500,000, including debt of $300,000 at 12%
interest. The investment will be used to acquire merchandise, equipment, and facilities, and
to cover initial operating costs. Expected sales each year will be $1,000,000, though sales could
be as low as $700,000. Annual expenses include wages of $100,000 plus sales commissions of
15% of sales, transportation costs of 8% of sales, cost of goods sold of 30% of sales, depreci-
ation of $80,000, insurance and miscellaneous costs of $30,000, and interest. The debt will be
repaid along with interest in equal annual installments over a five-year period. The business
will operate for five years and then be liquidated. The expected liquidation value is $200,000,
after repayment of debt. Each year $100,000 will be reinvested for asset replacement and up-
keep. The remaining cash flows will be distributed to the owners.

Required
A. Prepare an income statement for the company for the first year assuming (1) expected
sales and (2) minimum sales.
B. Calculate return on assets, return on equity, profit margin, and asset turnover for re-
sults based on (1) and (2) above.
C. Determine the annual debt payment and prepare an amortization schedule for the first
two years.
D. Prepare a cash flow statement for the company for year 1 based on (1) and (2) in part
A above, assuming that all cash flows are approximately equal to revenues and expenses
except depreciation. Also, calculate the cash distribution to owners.
E. Assuming that you require a 12% return on your investment, would you invest in this
business if annual sales are $1,000,000? If annual sales are $700,000? (Hint: Compare
the present value of expected cash distributions to the cost of the investment.)
F. Should you invest in this company? Support your opinion with material from parts A
through E and any other factors that you feel are relevant. Evaluate any risks involved,
including those related to high financial or operating leverage.
APPENDIX A

Coca-Cola Annual Report: Letter to Shareholders




Reprinted with permission of the Coca-Cola Company.




573
A1
A2 APPENDIX A
574 Appendix: Coca-Cola Annual Report: Letter to Shareholders
A3
APPENDIX A
575
Appendix: Coca-Cola Annual Report: Letter to Shareholders
A4 APPENDIX A
576 Appendix: Coca-Cola Annual Report: Letter to Shareholders
A5
APPENDIX A
577
Appendix: Coca-Cola Annual Report: Letter to Shareholders
APPENDIX B

General Mills, Inc.
2002 Annual Report
To Our Shareholders 1
Management’s Discussion and Analysis 12
Six-Year Financial Summary 18
Report of Management Responsibilities 19
Independent Auditor’s Report 19
Consolidated Statements of Earnings 20
Consolidated Balance Sheets 21
Consolidated Statements of Cash Flows 22
Consolidated Statements of Stockholder’s Equity 23
Notes to Consolidated Financial Statments 24
Corporate Directory 40
Shareholder Information 41




579
B1
581
582
583
584
585
586
587
588
589
590
591
592
593
594
595
596
597
598
599
600
601
602
603
604
605
606
607
608
609
610
611
612
613
614
615
616
617
618
619
620
621
622
623
624
APPENDIX C

Sources of Information about Companies
and Industries
Many college and public libraries offer print and electronic resources that provide in-
formation about companies and industries. The following listing describes some of the
resources you may find useful. The listing is not comprehensive. Check with your li-
brarian for other resources that may be available in your library.

Industry Classification
• The North American Industry Classification System (NAICS) categorizes companies
using an industry classification code. Companies with the same classification code
produce similar products. Other reference materials often use NAICS codes to iden-
tify companies and industries. You can find the NAICS codes on the Web at
http://www.census.gov/epcd/www/naics.html.
• The Standard Industrial Classification Manual provides an earlier system for classi-
fying companies and industries. Some reference materials still use Standard Indus-
trial Classification (SIC) codes to organize information. You can find SIC codes on
the Web at http://www.osha.gov/oshstats/sicser.html.

Business Periodicals
• Business Week provides general coverage of a wide variety of business issues, in-
cluding individual companies and industries. Some articles are available on the Web
at http://www.businessweek.com/.
• Fortune provides descriptive articles on many companies and industries. Special is-
sues provide rankings of companies by sales, both overall and within industries.
Some articles are available on the Web at http://www.fortune.com/.
• Forbes provides descriptive articles on many companies and industries. Special is-
sues provide summary information for large companies. Some articles are available
on the Web at http://www.forbes.com/.
• The Wall Street Journal provides daily coverage of major events related to specific
companies and industries as well as the overall economy. Some articles are avail-
able on the Web at http://www.wsj.com/.

Company Profiles
• Hoover’s Handbook of American Business gives profiles of companies, including
overview, history, financial data, products and brands, and major competitors. Even
more company profiles are available at Hoover’s Online at http://www.hoovers.com/.
• Standard & Poor’s Corporation Records provides a brief profile and financial infor-
mation on public companies. Standard & Poor’s Stock Reports also provides a brief
profile but includes more information about the company’s stock. Information

C1 625
C2 APPENDIX C
626 Appendix: Sources of Information About Companies and Industries

from both sources is also included in the electronic database from Standard & Poor’s
called NetAdvantage.
• Mergent (formerly Moody’s) Industrial Manual provides profiles of companies, in-
cluding history, subsidiaries, financial information, and a description of the com-
pany’s long-term debt and equity offerings. Other manuals cover other industries,
such as transportation and public utilities. This information is also available in Mer-
gent’s electronic database called FIS Online.
• Thomson Research (formerly Global Access) is an electronic database that contains
extensive information on companies such as financial information, stock data, and
so on.
• Factiva.com (formerly Dow Jones Interactive) provides several ways to research a
company. Look at company filings, review stock price history, or search for arti-
cles about the company in the Publications Library.
• Value Line Investment Survey provides analysis and commentary on major indus-
tries and companies.
• EDGAR offers free access to public company filings with the Securities and Ex-
change Commission. Visit EDGAR on the Web at http://www.sec.gov/edgar.shtml.
• A company’s annual report to the shareholders often contains useful information
about its products and markets in addition to their financial statements. Many com-
panies now post their annual report on their Web site. Use your favorite search en-
gine (e.g., Google at http://www.google.com/) to search for the company’s home
page. Look for an “Information for Investors” or “Investor Relations” section to
find the company’s annual report.
• International Directory of Company Histories is a large multi-volume set that gives
extensive background information on the history of individual companies.

Industry Profiles
• Standard & Poor’s Industry Surveys provides detailed analysis of over 50 major in-
dustries. This information is also contained in the electronic database from Stan-
dard & Poor’s called NetAdvantage.
• Encyclopedia of American Industries gives profiles of industries arranged by SIC code.
Almost every code has a profile, so information can be quite specific.
• U.S. Industry & Trade Outlook (formerly U.S. Industrial Outlook) contains infor-
mation on major industries in the United States, along with forecasts of future
prospects.
• Manufacturing & Distribution USA gathers industry statistics from the U.S. Census
Bureau and other sources and organizes them by SIC code.
• Marketresearch.com contains market research reports on individual industries and
types of products.

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