Chapter 2, Problem 2.11E

(a)

To determine

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.

Formula of current ratio:

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

Explanation of Solution

Compute current ratio of Company AE for 2017, if current assets are $925,359,000 and current liabilities are $401,763,000.

$\text{EPS = }\frac{\text{Net income – Preferred dividends}}{\text{Weighted average common shares outstanding}}$

Compute current ratio of Company AE for 2016, if current assets are $1,020,834,000 and current liabilities are $376,178,000.

$\text{Debt to assets ratio = }\frac{\text{Total liabilities}}{\text{Total assets}}$

(b)

To determine

Earnings per share (EPS): The amount of net income available to each shareholder per common share outstanding is referred to as earnings per share (EPS).

Use the following formula to compute EPS:

$\text{Free cash flow = }\left\{\begin{array}{l}\text{Net cash provided by operating activities–}\\ \text{Capital expenditures–}\\ \text{Dividends}\end{array}\right\}$

To determine: (b) EPS of Company AE for 2016 and 2017.

Explanation of Solution

Compute EPS of Company AE for 2017, if net income is $179,061,000, preferred dividends are $0, and weighted common shares outstanding are 205,169,000 shares.

$\begin{array}{c}\text{Current ratio = }\frac{\text{Current assets}}{\text{Current liabilities}}\\ =\frac{\$925,359,000}{\$401,763,000}\\ =2.30:1\end{array}$

Compute EPS of Company AE for 2016, if net income is $400,019,000, preferred dividends are $0, and weighted common shares outstanding are 216,119,000 shares.

$\begin{array}{c}\text{Current ratio = }\frac{\text{Current assets}}{\text{Current liabilities}}\\ =\frac{\$1,020,834,000}{\$376,178,000}\\ =2.71:1\end{array}$

(c)

To determine

Debt to assets ratio: This financial ratio evaluates the ability of a company to pay off long-term debt obligations owed to creditors. This ratio assesses the solvency of a company.

Formula of debt to assets ratio:

$\begin{array}{c}\text{EPS = }\frac{\text{Net income – Preferred dividends}}{\text{Weighted average common shares outstanding}}\\ \text{=}\frac{\text{\$179,061,000–\$0}}{\text{205,169,000 shares}}\\ \text{= \$0}\text{.87 per share}\end{array}$

To determine: (c) Deb to assets ratio of Company AE for 2016 and 2017.

Explanation of Solution

Compute debt to assets ratio for Company AE for the year 2017, if total assets are $1,963,676,000 and total liabilities are $554,645,000.

$\begin{array}{c}\text{EPS = }\frac{\text{Net income – Preferred dividends}}{\text{Weighted average common shares outstanding}}\\ \text{=}\frac{\text{\$400,019,000–\$0}}{\text{216,119,000 shares}}\\ \text{= \$1}\text{.85 per share}\end{array}$

Compute debt to assets ratio for Company AE for the year 2016, if total assets are $1,867,680,000 and total liabilities are $527,216,000.

$\begin{array}{c}\text{Debt to assets ratio = }\frac{\text{Total liabilities}}{\text{Total assets}}\\ \text{=}\frac{\text{\$554,645,000}}{\text{\$1,963,676,000}}\\ \text{= 0}\text{.282 or 28}\text{.2\%}\end{array}$

(d)

To determine

Free cash flow: This measure evaluates the cash-generating capacity of a company from its operating activities, after paying capital expenditures and dividends.

Formula of free cash flow:

$\begin{array}{c}\text{Debt to assets ratio = }\frac{\text{Total liabilities}}{\text{Total assets}}\\ \text{=}\frac{\text{\$527,216,000}}{\text{\$1,867,680,000}}\\ \text{= 0}\text{.282 or 28}\text{.2\%}\end{array}$

To determine: (d) Free cash flow of Company AE for 2016 and 2017.

Explanation of Solution

Compute free cash flow for Company AE for 2017, if net cash provided by operating activities is $302,193,000, capital expenditures are $265,335,000, preferred dividends paid are $82,394,000.

$\begin{array}{c}\text{Free cash flow = }\left\{\begin{array}{l}\text{Net cash provided by operating activities–}\\ \text{Capital expenditures–}\\ \text{Dividends paid}\end{array}\right\}\\ =\$302,193,000–\$265,335,000–\$82,394,000\\ =\$\left(45,536,000\right)\end{array}$

Compute free cash flow for Company AE for 2016, if net cash provided by operating activities is $464,270,000, capital expenditures are $250,407,000, dividends paid are $80,796,000.

$\begin{array}{c}\text{Free cash flow = }\left\{\begin{array}{l}\text{Net cash provided by operating activities–}\\ \text{Capital expenditures–}\\ \text{Dividends paid}\end{array}\right\}\\ =\$464,270,000–\$250,407,000–\$80,796,000\\ =\$130,067,000\end{array}$

(e)

To determine

(e) Comment on the changes in solvency from 2016 to 2017.

Explanation of Solution

Comparison of solvency of Company AE: Free cash flow and debt to assets ratio assess the solvency of a company. Free cash flow has decreased from $133,067,000 in 2016 to $(45,536,000) in 2017. This shows that solvency of Company AE has decreased. Debt to assets ratio is the same in 2016 and 2017 with 28.2%. This shows that solvency has deteriorated from 2016 to 2017.

(f)

To determine

(f) Analyze the ability of Company AE in meeting its investment requirements

Explanation of Solution

Analysis of the ability of Company AE in meeting its investment requirements: In 2016, the net cash provided from operating activities was $464,270,000 and capital expenditures was $250,407. But in 2017, the net cash provided from operating activities, $302,193,000 reduced and capital expenditures, $265,335, increased. Hence, there is a deficiency. This could be met by raising either stock capital or debt capital.