Tutorial Questions 1 - Solution

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Tutorial Questions 1 - Solutions

2 - 13. Martha and Hannah are equal partners in a retail knitting store. Total equity in the store is $800,000, so they own $400,000 each. Based on their expectations about opportunity cost, they both expect to earn a 10% return on their invested capital plus $75,000 each in lieu of the salary they could be earning if they had a regular job. Ignoring taxes, how much operating profit are they expecting to make? Equity capital ($800,000 × 10%) $ 80,000 Salary opportunity cost ($75,000 × 2) 150,000 Expected operating profit $230,000

3-8. Baker’s Haulage is a trucking business. Expenses include truck repairs. The following repair-related transactions happened in the current year: (i) On January 1, $550 was owed for repairs carried out in the previous year. (ii) During the year, a total of $25,000 was paid out to repair shops. (iii) On December 31, $750 was owed to repair shops. Required Calculate the truck repair expense for the year. Cash paid in year $25,000 Add: Owed at end of year 750 Less: Owed at beginning of year (550) Truck repair expenses for the year $25,200

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4-4. When Mercator Manufacturing Inc. checked its stores, it had the following inventory on hand as at December 31, 2015: Required (a) Show how the inventory would appear in the balance sheet as at December 31, 2015. (i) 5,000 litres of lubricating oil that had cost $2.50 per litre: As at December 31, the replacement price was $3.00 per litre. Lubricating oil, at cost: 5,000 litres @ $2.50 $12,500 (ii) 50,000 kg of steel that had cost $0.50 per kg: As at December 31, the replacement price was $0.48 per kg. Steel at replacement cost: 50,000 kg @ $0.48 $24,000 (iii) Spare parts that had cost $25,000: Mostly for production machinery that was no longer in use, so it was unlikely they could be used. They have no resale value. No value $0 (iv) A replacement control unit for a customer’s milling machine, which has a resale value of $10,000: The control unit was bought by the customer so that Mercator could use it to repair their milling machine. Not a company owned asset $0 (v) $20,000 of electronic parts that were in good working order but had gone beyond their “sell by” dates on the packages. Electronic parts: at lower of cost of market value $0 Total: Inventory at lower of cost or market value $36,500 (b) If Mercartor Manufacturing’s sales for 2015 totalled $500,000, calculate the following: • The inventory turnover ratio SR ÷ I = $500,000 ÷ $36,500 = 13.7 times • The inventory holding period I ÷ (SR ÷ 365) = $36,500 ÷ (500,000 ÷ 365) = 26.6 days

5-5. Jones Co. has the following assets, liabilities and shareholders’ equity:  Cash: $50,000  Inventory: $250,000  Trade accounts receivable: $100,000  Long-term assets (net of depreciation): $500,000  Trade accounts payable: $300,000  Long-term debt: $100,000  Shareholders’ equity: $500,000 Required (a) Calculate the debt to equity ratio. DE = D ÷ E = ($300,000 + $100,000)/$500,000 = 80% (b) Calculate the debt to assets ratio. DA= D ÷ TA = ($300,000 + $100,000) ÷ ($50,000 + $250,000 + $100,000 + $500,000) = $400,000 ÷ $900,000 = 44.44% (c) Comment on the leverage of the company . Both the debt to equity ratio (80%) and the debt to assets ratio (44.44%) are at the upper limit (100% and 50%, respectively) of what is recognized to be prudent. They are at the high end of the normal risk level in respect of debt.

6-4. Dollar Co. made a net profit of $800,000 in the year. Depreciation expense was $100,000. During the year, accounts receivable decreased by $50,000, and inventory increased by $25,000. Trade accounts payable increased by $75,000. Required Calculate the cash from or cash used in operations. Cash from/used in operations: Net income $ 800,000 Add: Amortization expense 100,000 Net decrease in non-cash working capital (–$50,000 + $25,000 – $75,000) 100,000 Cash from operations $1,000,000

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P7-2. BCE Inc. (formerly Bell Canada) is the 10th largest Canadian public company. Below are BCE Inc.’s summarized financial statements for 2019 and 2018. BCE Inc. Consolidated Income Statements ($ millions) For the Year Ended December 31 2019 2018 Revenue $ 23,964 $ 23,468 Operating costs (except depreciation & amortization) $(13,985) $(14,417) Depreciation & amortization (4,398 ) (4,014 ) Total operating costs $(18,383 ) $ 18,431 Operating income $ 5,581 $ 5,037 Interest expense (1,195) (1,069) Income tax expense $ (1,133 ) $ (995 ) Net income $ 3,253 $ 2,973 # common shares outstanding (millions) 900.8 898.6 Share price (annual average) $62.48 $55.76 BCE Inc. Statement of Financial Position (Balance Sheet) ($ millions) As at December 31 2019 2018 Assets Current assets Cash & cash equivalents $ 145 $ 425 Trade and other receivables 3,038 3,006 Inventory & net contract assets 1,953 1,789 Prepaid expense & other current assets 384 573 Total current assets $ 5,520 $ 5,793 Non-current assets Net contract assets $ 901 $ 843 Property, plant & equipment 27,636 24,844 Intangible assets 13,352 13,205 Other non-current assets 2,070 1,757 Goodwill 10,667 10,658 Total non-current assets $54,626 $51,307 Total assets $60,146 $57,100 Liabilities & Shareholders’ Equity Current liabilities $ 9,777 $10,429 Non-current liabilities 28,961 25,982 Total liabilities $38,738 $36,411 Total equity $21,408 $20,689 Total liabilities & equity $60,146 $57,100

BCE Inc. Statement of Changes in Equity ($ billions) 2019 Equity as at January 1, 2019 $20,689 Operating income 3,253 Dividends (3,008) Other adjustments, net 564 Equity as at December 31, 2019 $21,498 Required Use the financial statement information to calculate appropriate financial ratios and use the financial ratios to comment on how well the company is doing . Year 2019 2018 Comment Liquidity Current ratio: 5,520 ÷ 9,777 = 0.56:1 5,793 ÷ 10,429 = 0.56:1 Quite low (< 2:1) Quick ratio: (5,520 – 1,953) ÷ 9,777 = 0.36:1 (5,793 – 1,789) ÷ 10,429 = 0.38:1 Quite low (< 1:1) We normally expect companies to have a current ratio of at least 2:1 and (more importantly) a quick ratio of at least 1:1. BCE is way below these expectations. It is, however, consistent over the 2 years. The notes to the accounts show that they have a “revolving credit facility of $4 billion” from banks, so liquidity does not appear to be an issue. Profitability Operating profit as % of sales: 5,581 ÷ 23,964 × 100% = 23.3% 5,037 ÷ 23,468 × 100% = 21.5% Healthy returns, which are all increasing Operating profit as % of assets: 5,581 ÷ 60,146 × 100% = 9.3% 5,037 ÷ 57,100 × 100% = 8.8% Net income as % of equity: 3,253 ÷ 21,408 × 100% = 15.2% 2,973 ÷ 20,689 × 100% = 14.4%

Year 2019 2018 Comment Debt Debt as % of assets: 38,738 ÷ 60,146 × 100% = 64.4% 36,411 ÷ 57,100 × 100% = 63.8% Quite high (> 50%) The debt to equity ratio would tell the same story. Interest cover ratio: 5,581 ÷ 1,195 = 4.7X 5,037 ÷ 1,069 = 4.7X Interest is well covered by profits Market-related ratios Earnings per share: 3,253 ÷ 901 = $3.61 2,973 ÷ 899 = $3.31 Slight growth Price to earnings ratio: $62.48 ÷ $3.61 = 17.3X $55.76 ÷ $3.31 = 16.8X Quite high Dividend cover ratio 3,253 ÷ 3,008 = 1.08X Only just covered. The notes to the accounts state that their policy is to pay out between 65% and75% of “free cash flow” as dividends each year.

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