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# Acc202 Survey of Accounting: P10-21 The following transactions pertain to 2012, the first year of

Acc202 Survey of Accounting

P10-21 Discuss the differentiation between product versus general, selling, and administrative cost by setting up financial statements from the transactions.

The following transactions pertain to 2012, the first year of operations of Hall Company. All inventory was started and completed during 2012. Assume all transactions are cash transactions.

1. Acquired $4,000 cash by issuing common stock

2. Paid $720 for materials used to produce inventory.

3. Paid $1,800 to production workers

4. Paid $540 rental fee for production equipment

5. Paid $180 administrative employees.

6. Paid $144 rental fee for administrative office equipment

7. Produced 300 units of inventory of which 200 were sold at 12 each.

Required

Prepare an income statement, balance sheet, and statement of cash flows.

P10-21 Discuss the differentiation between product versus general, selling, and administrative cost by setting up financial statements from the transactions.

The following transactions pertain to 2012, the first year of operations of Hall Company. All inventory was started and completed during 2012. Assume all transactions are cash transactions.

1. Acquired $4,000 cash by issuing common stock

2. Paid $720 for materials used to produce inventory.

3. Paid $1,800 to production workers

4. Paid $540 rental fee for production equipment

5. Paid $180 administrative employees.

6. Paid $144 rental fee for administrative office equipment

7. Produced 300 units of inventory of which 200 were sold at 12 each.

Required

Prepare an income statement, balance sheet, and statement of cash flows.

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Acc346 Managerial Accounting

(TCO 4) Beach Rentals has estimated that fixed costs per month are $79,200 and variable cost per dollar of sales is $0.52.

(a) What is the break-even point per month in sales?

(b) What level of sales is needed for a monthly profit of $24,000?

(c) For the month of July, the company anticipates sales of $240,000. What is the expected level of profit? (Points : 25)

(TCO 4) Beach Rentals has estimated that fixed costs per month are $79,200 and variable cost per dollar of sales is $0.52.

(a) What is the break-even point per month in sales?

(b) What level of sales is needed for a monthly profit of $24,000?

(c) For the month of July, the company anticipates sales of $240,000. What is the expected level of profit? (Points : 25)

BA350 Financial Management

16-7 Break-Even Point

Schweser Satellites Inc. produces satellite earth stations that sell for $100,000 each. The firm’s fixed costs, F, are $2 million; 50 earth stations are produced and sold each year; profits total $500,000; and the firm’s assets (all equity financed) are $5 million. The firm estimates that it can change its production process, adding $4 million to investment and $500,000 to fixed operating costs. This change will (1) reduce variable costs per unit by $10,000 and (2) increase output by 20 units, but (3) the sales price on all units will have to be lowered to $95,000 to permit sales of the additional output. The firm has tax loss carryforwards that cause its tax rate to be zero, its cost of equity is 16%, and it uses no debt.

a. What is the incremental profit? To get a rough idea of the project’s profitability, what is the project’s expected rate of return for the next year (defined as the incremental profit divided by the investment)? Should the firm make the investment?

b. Would the firm’s break-even point increase or decrease if it made the change?

c. Would the new situation expose the firm to more or less business risk than the old one?

16-7 Break-Even Point

Schweser Satellites Inc. produces satellite earth stations that sell for $100,000 each. The firm’s fixed costs, F, are $2 million; 50 earth stations are produced and sold each year; profits total $500,000; and the firm’s assets (all equity financed) are $5 million. The firm estimates that it can change its production process, adding $4 million to investment and $500,000 to fixed operating costs. This change will (1) reduce variable costs per unit by $10,000 and (2) increase output by 20 units, but (3) the sales price on all units will have to be lowered to $95,000 to permit sales of the additional output. The firm has tax loss carryforwards that cause its tax rate to be zero, its cost of equity is 16%, and it uses no debt.

a. What is the incremental profit? To get a rough idea of the project’s profitability, what is the project’s expected rate of return for the next year (defined as the incremental profit divided by the investment)? Should the firm make the investment?

b. Would the firm’s break-even point increase or decrease if it made the change?

c. Would the new situation expose the firm to more or less business risk than the old one?

BA350 Financial Management

19-3 New Stock Issue

The Edelman Gem Company, a small jewelry manufacturer, has been successful and has enjoyed a good growth trend. Now Edelman is planning to go public with an issue of common stock, and it faces the problem of setting an appropriate price on the stock. The company and its investment banks believe that the proper procedure is to select several similar firms with publicly traded common stock and to make relevant comparisons.

Several jewelry manufacturers are reasonably similar to Edelman with respect to product mix, asset composition, and debt/equity proportions. Of these companies, Kennedy Jewelers and Strasburg Fashions are most similar. When analyzing the following data, assume that 2002 and 2007 were reasonably “normal” years for all three companies— that is, these years were neither especially good nor especially bad in terms of sales, earnings, and dividends. At the time of the analysis, rRF was 8% and RPM was 4%. Kennedy is listed on the AMEX and Strasburg on the NYSE, while Edelman will be traded in the Nasdaq market.

Kennedy Strasburg Edelman (Totals)

Earnings per share*

2007 4.50 7.50 1,200,000

2002 3.00 5.50 816,000

Price per share*

2007 36.00 65.00

Dividends per share*

2007 2.25 3.75 600,000

2002 1.50 2.75 420,000

Book value per share, 2007* 30.00 55.00 9,000,000

Market/book ratio, 2007 120% —

Total assets, 2007 (in millions) $28 $82 $20

Total debt, 2007 (in millions) $12 $30 $11

Sales, 2007 (in millions) $41 $140 $37

*The data are on a per share basis for Kennedy and Strasburg, but are totals for Edelman.

a. Assume that Edelman has 100 shares of stock outstanding. Use this information to calculate earnings per share (EPS), dividends per share (DPS), and book value per share for Edelman. (Hint: Edelman’s 2007 EPS _ $12,000.)

b. Calculate earnings and dividend growth rates for the three companies. (Hint: Edelman’s EPS growth rate is 8%.)

c. On the basis of your answer to part a, do you think Edelman’s stock would sell at a price in the same “ballpark” as that of Kennedy and Strasburg, that is, in the range of $25 to $100 per share?

d. Assuming that Edelman’s management can split the stock so that the 100 shares could be changed to 1,000 shares, 100,000 shares, or any other number, would such an action make sense in this case? Why or why not?

e. Now assume that Edelman did split its stock and has 400,000 shares. Calculate new values for EPS, DPS, and book value per share. (Hint: Edelman’s new 2007 EPS is $3.00.)

f. Return on equity (ROE) can be measured as EPS/book value per share or as total earnings/total equity. Calculate ROEs for the three companies for 2007. (Hint: Edelman’s 2007 ROE is 13.3%.)

g. Calculate dividend payout ratios for the three companies for both years. (Hint: Edelman’s 2007 payout ratio is 50%.)

h. Calculate debt/total assets ratios for the three companies for 2007. (Hint: Edelman’s 2007 debt ratio is 55%.)

i. Calculate the P/E ratios for Kennedy and Strasburg for 2007. Are these P/Es reasonable in view of relative growth, payout, and ROE data? If not, what other factors might explain them? (Hint: Kennedy’s P/E _ 8_.)

j. Now determine a range of values for Edelman’s stock price, with 400,000 shares outstanding, by applying Kennedy’s and Strasburg’s P/E ratios, price/dividends ratios, and price/book value ratios to your data for Edelman. For example, one possible price for Edelman’s stock is (P/E Kennedy)(EPS Edelman) _ 8($3) _ $24 per share. Similar calculations would produce a range of prices based on both Kennedy’s and Strasburg’s data. (Hint: Our range was $24 to $27.)

k. Using the equation rs _ D1/P0 _ g, find approximate rs values for Kennedy and Strasburg. Then use these values in the constant growth stock price model to find a price for Edelman’s stock. (Hint: We averaged the EPS and DPS g’s for Edelman.)

l. At what price do you think Edelman’s shares should be offered to the public? You will want to select a price that will be low enough to induce investors to buy the stock but not so low that it will rise sharply immediately after it is issued. Think about relative growth rates, ROEs, dividend yields, and total returns (rs _ D1/P0 _ g).

19-3 New Stock Issue

The Edelman Gem Company, a small jewelry manufacturer, has been successful and has enjoyed a good growth trend. Now Edelman is planning to go public with an issue of common stock, and it faces the problem of setting an appropriate price on the stock. The company and its investment banks believe that the proper procedure is to select several similar firms with publicly traded common stock and to make relevant comparisons.

Several jewelry manufacturers are reasonably similar to Edelman with respect to product mix, asset composition, and debt/equity proportions. Of these companies, Kennedy Jewelers and Strasburg Fashions are most similar. When analyzing the following data, assume that 2002 and 2007 were reasonably “normal” years for all three companies— that is, these years were neither especially good nor especially bad in terms of sales, earnings, and dividends. At the time of the analysis, rRF was 8% and RPM was 4%. Kennedy is listed on the AMEX and Strasburg on the NYSE, while Edelman will be traded in the Nasdaq market.

Kennedy Strasburg Edelman (Totals)

Earnings per share*

2007 4.50 7.50 1,200,000

2002 3.00 5.50 816,000

Price per share*

2007 36.00 65.00

Dividends per share*

2007 2.25 3.75 600,000

2002 1.50 2.75 420,000

Book value per share, 2007* 30.00 55.00 9,000,000

Market/book ratio, 2007 120% —

Total assets, 2007 (in millions) $28 $82 $20

Total debt, 2007 (in millions) $12 $30 $11

Sales, 2007 (in millions) $41 $140 $37

*The data are on a per share basis for Kennedy and Strasburg, but are totals for Edelman.

a. Assume that Edelman has 100 shares of stock outstanding. Use this information to calculate earnings per share (EPS), dividends per share (DPS), and book value per share for Edelman. (Hint: Edelman’s 2007 EPS _ $12,000.)

b. Calculate earnings and dividend growth rates for the three companies. (Hint: Edelman’s EPS growth rate is 8%.)

c. On the basis of your answer to part a, do you think Edelman’s stock would sell at a price in the same “ballpark” as that of Kennedy and Strasburg, that is, in the range of $25 to $100 per share?

d. Assuming that Edelman’s management can split the stock so that the 100 shares could be changed to 1,000 shares, 100,000 shares, or any other number, would such an action make sense in this case? Why or why not?

e. Now assume that Edelman did split its stock and has 400,000 shares. Calculate new values for EPS, DPS, and book value per share. (Hint: Edelman’s new 2007 EPS is $3.00.)

f. Return on equity (ROE) can be measured as EPS/book value per share or as total earnings/total equity. Calculate ROEs for the three companies for 2007. (Hint: Edelman’s 2007 ROE is 13.3%.)

g. Calculate dividend payout ratios for the three companies for both years. (Hint: Edelman’s 2007 payout ratio is 50%.)

h. Calculate debt/total assets ratios for the three companies for 2007. (Hint: Edelman’s 2007 debt ratio is 55%.)

i. Calculate the P/E ratios for Kennedy and Strasburg for 2007. Are these P/Es reasonable in view of relative growth, payout, and ROE data? If not, what other factors might explain them? (Hint: Kennedy’s P/E _ 8_.)

j. Now determine a range of values for Edelman’s stock price, with 400,000 shares outstanding, by applying Kennedy’s and Strasburg’s P/E ratios, price/dividends ratios, and price/book value ratios to your data for Edelman. For example, one possible price for Edelman’s stock is (P/E Kennedy)(EPS Edelman) _ 8($3) _ $24 per share. Similar calculations would produce a range of prices based on both Kennedy’s and Strasburg’s data. (Hint: Our range was $24 to $27.)

k. Using the equation rs _ D1/P0 _ g, find approximate rs values for Kennedy and Strasburg. Then use these values in the constant growth stock price model to find a price for Edelman’s stock. (Hint: We averaged the EPS and DPS g’s for Edelman.)

l. At what price do you think Edelman’s shares should be offered to the public? You will want to select a price that will be low enough to induce investors to buy the stock but not so low that it will rise sharply immediately after it is issued. Think about relative growth rates, ROEs, dividend yields, and total returns (rs _ D1/P0 _ g).