Chapter 12, Problem 4EYK

a.

To determine

Calculate the Corporation PK’s current ratio for Year 1, Year 2 and Year 3.

Explanation of Solution

Current ratio: The financial ratio which evaluates the ability of a company to pay off the debt obligations which mature within one year or within completion of operating cycle is referred to as current ratio. This ratio assesses the liquidity of a company.

Current ratio is calculated by using the formula:

$\text{Current ratio}=\frac{\text{Current assets}}{\text{Current liabilities}}$

Calculate the current ratio for year 1:

Current assets for year 1 is $1,055,776,000

Current liabilities for year 2 is $358,729,000

$\begin{array}{c}\text{Current ratio }=\frac{\text{Current asset}}{\text{Current liability}}\\ =\frac{\$1,055,776,000}{\$358,729,000}\\ =2.94\end{array}$

Hence, the current ratio for Year 1 is 2.94.

Calculate the current ratio for year 2:

Current assets for year 2 is $1,056,443,000

Current liabilities for year 2 are $468,254,000

$\begin{array}{c}\text{Current ratio }=\frac{\text{Current asset}}{\text{Current liability}}\\ =\frac{\$1,056,443,000}{\$468,254,000}\\ =2.26\end{array}$

Hence, the current ratio for Year 2 is 2.26.

Calculate the current ratio for year 3.

Current assets for year 3 is $1,018,354,000

Current liabilities for year 3 are $504,444,000

$\begin{array}{c}\text{Current ratio }=\frac{\text{Current asset}}{\text{Current liability}}\\ =\frac{\$1,018,354,000}{\$504,444,000}\\ =2.02\end{array}$

Hence, the current ratio for Year 2 is 2.02.

b.

To determine

Calculate operating cash flow to current liabilities ratio for Year 1, Year 2 and Year 3.

Explanation of Solution

Operating cash flow to current liabilities ratio measures the capability of the company to pay it current liabilities. In this, higher the ratio shows that the company has sufficient cash flow to pay its debts.

Formula to calculate the operating cash flow to current liabilities ratio is:

$\begin{array}{l}\text{Operating cash flows}\\ \text{ to current liabilities ratio}\end{array})=\frac{\text{Cash flows from operating activities}}{\text{Average current liabilities}}$

Calculate the operating cash flow to current liabilities ratio for Year 1.

Operating cash flow from operating activities for Year 1 is $235,186,000

Average current liabilities for Year 1 is $352,161,500 (1)

$\begin{array}{c}\begin{array}{l}\text{Operating cash flows}\\ \text{ to current liabilities ratio}\end{array})=\frac{\text{Cash flows from operating activities}}{\text{Average current liabilities}}\\ =\frac{\$235,186,000}{\$352,161,500}\\ =0.67\end{array}$

Working note:

Calculate the average current liabilities for Year 1.

$\begin{array}{c}\text{Average current liabilities }=\frac{\left(\begin{array}{l}\text{Current liabilities, beginning }\\ +\text{ Current liabilities, ending}\end{array}\right)}{2}\\ =\frac{\$345,594,000+358,729,000}{2}\\ =\$352,161,500\end{array}$ (1)

Thus, the operating cash flow to current liabilities ratio is 0.67.

Calculate the operating cash flow to current liabilities ratio for Year 2.

Operating cash flow from operating activities for Year 2 is $229,382,000

Average current liabilities for Year 2 is $413,491,500 (2)

$\begin{array}{c}\begin{array}{l}\text{Operating cash flows}\\ \text{ to current liabilities ratio}\end{array})=\frac{\text{Cash flows from operating activities}}{\text{Average current liabilities}}\\ =\frac{\$229,382,000}{\$413,491,500}\\ =0.55\end{array}$

Working note:

Calculate the average current liabilities for Year 2.

$\begin{array}{c}\text{Average current liabilities }=\frac{\left(\begin{array}{l}\text{Current liabilities, beginning }\\ +\text{ Current liabilities, ending}\end{array}\right)}{2}\\ =\frac{358,729,000+\$468,254,000}{2}\\ =\$413,491,500\end{array}$ (2)

Thus, the operating cash flow to current liabilities ratio is 0.55.

Calculate the operating cash flow to current liabilities ratio for Year 3.

Operating cash flow from operating activities for Year 3 is $259,204,000

Average current liabilities for Year 3 is $486,349,000 (3)

$\begin{array}{c}\begin{array}{l}\text{Operating cash flows}\\ \text{ to current liabilities ratio}\end{array})=\frac{\text{Cash flows from operating activities}}{\text{Average current liabilities}}\\ =\frac{\$259,204,000}{\$486,349,000}\\ =0.53\end{array}$

Working note:

Calculate the average current liabilities for Year 3.

$\begin{array}{c}\text{Average current liabilities }=\frac{\left(\begin{array}{l}\text{Current liabilities, beginning}\\ +\text{ Current liabilities, ending}\end{array}\right)}{2}\\ =\frac{\$468,254,000+\$504,444,000}{2}\\ =\$486,349,000\end{array}$ (3)

Thus, the operating cash flow to current liabilities ratio is 0.53.

c.

To determine

Comment on three-year trend in current ratio and operating cash flow to current liabilities ratio.

Explanation of Solution

Year 1:

• By evaluating the current ratio for year 1 is 2.94, it indicates that the company has enough current assets to settle the current liabilities.
• By computing the operating cash flows to current liabilities ratio is 0.67, it indicates that the ratio is higher than the Industry average by which the company is having adequate operating cash flows to settle the current liabilities.

Year 2:

• By evaluating the current ratio for year 2 is 2.26, it indicates that the company has enough current assets to settle the current liabilities.
• By computing the operating cash flows to current liabilities ratio is 0.55, it indicates that the ratio is higher than the Industry average by which the company is having adequate operating cash flows to settle the current liabilities.

Year 3:

• By evaluating the current ratio for year 3 is 2.02, it indicates that the company has enough current assets to settle the current liabilities.
• By computing the operating cash flows to current liabilities ratio is 0.53, it indicates that the ratio is higher than the Industry average by which the company is having adequate operating cash flows to settle the current liabilities.

d.

To determine

Compute the operating cash flow to capital expenditure ratio and comment on the strength of this ratio for Year 1, Year 2 and Year 3.

Explanation of Solution

Calculate the operating cash flow to capital expenditure ratio for Year 1.

Cash flows from operating activities is $235,186,000

Annual net capital expenditure is 84,955,000

$\begin{array}{c}\begin{array}{l}\text{Operating cash flows}\\ \text{ to capital expenditure ratio}\end{array})=\frac{\text{Cash flows from operating activities}}{\text{Annual net capital expenditure}}\\ =\frac{\$235,186,000}{\$84,955,000}\\ =2.77\end{array}$

Thus, the operating cash flows to capital expenditure ratio are 2.77. This indicates that the ratio is higher than the standard ratio of 1.0. Hence, there is an operating cash efficiency to finance the capital expenditure requirement of the company is strong.

Calculate the operating cash flow to capital expenditure ratio for Year 2.

Cash flows from operating activities is $229,382,000

Annual net capital expenditure is $91,484,000

$\begin{array}{c}\begin{array}{l}\text{Operating cash flows}\\ \text{ to capital expenditure ratio}\end{array})=\frac{\text{Cash flows from operating activities}}{\text{Annual net capital expenditure}}\\ =\frac{\$229,382,000}{\$91,484,000}\\ =2.51\end{array}$

Thus, the operating cash flows to capital expenditure ratio are 2.51. This indicates that the ratio is higher than the standard ratio of 1.0. Hence, there is an operating cash efficiency to finance the capital expenditure requirement of the company is strong.

Calculate the operating cash flow to capital expenditure ratio for Year 3.

Cash flows from operating activities is $259,204,000

Annual net capital expenditure is $99,914,000

$\begin{array}{c}\begin{array}{l}\text{Operating cash flows}\\ \text{ to capital expenditure ratio}\end{array})=\frac{\text{Cash flows from operating activities}}{\text{Annual net capital expenditure}}\\ =\frac{\$259,204,000}{\$99,914,000}\\ =2.59\end{array}$

Thus, the operating cash flows to capital expenditure ratio are 2.59. This indicates that the ratio is higher than the standard ratio of 1.0. Hence, there is an operating cash efficiency to finance the capital expenditure requirement of the company is strong.