Chapter 2, Problem 2.7AP

(a)

To determine

Working capital: The measure which evaluates the ability of a company to pay off the short-term debt obligations, by computing the excess of current assets over current liabilities is referred to as working capital.

Formula of working capital:

$\text{Working capitla = Current assets}-\text{Current liabilities}$

To compute: (a) Working capital.

Explanation of Solution

Compute working capital of Corporation T, if current assets are $17,488,000,000 and current liabilities are $10,512,000,000.

$\begin{array}{c}\text{Working capital = Current assets}-\text{Current liabilities}\\ \text{=\$17,488,000,000}-\$10,512,000,000\\ =\$6,976,000,000\end{array}$

Compute working capital of Corporation W, if current assets are $48,949,000,000 and current liabilities are $55,390,000,000.

$\begin{array}{c}\text{Working capital = Current assets}-\text{Current liabilities}\\ \text{=\$48,949,000,000}-\$53,390,000,000\\ =\left(\$6,441,000,000\right)\end{array}$

(b)

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:

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

To compute: (b) Current ratio.

Explanation of Solution

Compute current ratio of Corporation T, if current assets are $17,488,000,000 and current liabilities are $10,512,000,000.

$\begin{array}{c}\text{Current ratio =}\frac{\text{ Current assets}}{\text{Current liabilities}}\\ =\frac{\$17,488,000,000}{\$10,512,000,000}\\ =1.66:1\end{array}$

Compute current ratio of Corporation W, if current assets are $48,949,000,000 and current liabilities are $55,390,000,000.

$\begin{array}{c}\text{Current ratio =}\frac{\text{ Current assets}}{\text{Current liabilities}}\\ =\frac{\$48,949,000,000}{\$55,390,000,000}\\ =.88:1\end{array}$

(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:

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

To compute: (c) Debt to assets ratio.

Explanation of Solution

Compute debt to assets ratio of Corporation T, if total assets are $44,106,000,000, current liabilities are $10,512,000,000, and long-term liabilities are $19,882,000,000.

$\begin{array}{c}\text{Debt to assets ratio = }\frac{\text{Total liabilities}\left(\text{Current and long-term}\right)}{\text{Total assets}}\\ =\frac{\text{\$10,512,000,000 + \$19,882,000,000}}{\text{\$44,106,000,000}}\\ =0.689\text{ or }68.9\%\end{array}$

Compute debt to assets ratio of Corporation W, if total assets are $163,429,000,000, current liabilities are $55,390,000,000, and long-term liabilities are $42,754,000,000.

$\begin{array}{c}\text{Debt to assets ratio = }\frac{\text{Total liabilities}\left(\text{Current and long-term}\right)}{\text{Total assets}}\\ =\frac{\text{\$55,390,000,000 + \$42,754,000,000}}{\text{\$163,429,000,000}}\\ =0.601\text{ or 60}\text{.1\%}\end{array}$

(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:

$\text{Free cash flow = }\left(\begin{array}{l}\text{Net cash provides by operating activities}\\ -\text{Capital expenditures}-\text{Dividends}\end{array}\right)$

To compute:  (d) Free cash flow.

Explanation of Solution

Compute free cash flow of Corporation T, if net cash provided by operating activities is $4,430,000,000, capital expenditures are $3,547,000,000, and dividends paid are $465,000,000.

$\begin{array}{c}\text{Free cash flow = }\left(\begin{array}{l}\text{Net cash provides by operating activities}\\ -\text{Capital expenditures}-\text{Dividends}\end{array}\right)\\ =\$4,430,000,000-\$3,547,000,000-\$465,000,000\\ =\$418,000,000\end{array}$

Compute free cash flow of Corporation W, if net cash provided by operating activities is $23,147,000,000, capital expenditures are $11,499,000,000, and dividends paid are $3,746,000,000.

$\begin{array}{c}\text{Free cash flow = }\left(\begin{array}{l}\text{Net cash provides by operating activities}\\ -\text{Capital expenditures}-\text{Dividends}\end{array}\right)\\ =\$23,147,000,000-\$11,499,000,000-\$3,746,000,000\\ =\$7,902,000,000\end{array}$

(e)

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).

Formula of EPS:

$\text{EPS =}\frac{\left(\text{ Net income}-\text{Preferred dividends}\right)}{\text{Weighted average common shares outstanding}}$

To compute: (e) EPS of Corporation T and Corporation W for 2017.

Explanation of Solution

Compute EPS of Corporation T, if net income is $2,214,000,000, preferred dividends are $0, and weighted common shares outstanding are 774,000,000 shares.

$\begin{array}{c}\text{EPS =}\frac{\left(\text{ Net income}-\text{Preferred dividends}\right)}{\text{Weighted average common shares outstanding}}\\ =\frac{\left(\text{ \$2,214,000,000}-\text{\$0}\right)}{\text{774,000,000 Shares}}\\ =\$2.86\text{Per share}\end{array}$

Compute EPS of Corporation W, if net income is $13,400,000,000, preferred dividends are $0, and weighted common shares outstanding are 3,951,000,000 shares.

$\begin{array}{c}\text{EPS =}\frac{\left(\text{ Net income}-\text{Preferred dividends}\right)}{\text{Weighted average common shares outstanding}}\\ =\frac{\left(\text{ \$13,400,000,000}-\text{\$0}\right)}{\text{3,951,000,000 Shares}}\\ =\$3.39\text{Per share}\end{array}$

To determine

(f)

Working capital: The measure which evaluates the ability of a company to pay off the short-term debt obligations, by computing the excess of current assets over current liabilities is referred to as working capital.

Formula of working capital:

$\text{Working capitla = Current assets}-\text{Current liabilities}$

To analyze: (f) the liquidity and solvency position of two companies based on the computed ratios

Explanation of Solution

Analysis:

• Working capital of Corporation T is $6,976,000 and current ratio is 1.66:1. Working capital of Corporation W is $(6,441,000,000) and current ratio is 0.88:1. Based on these ratios, it can be inferred that the Corporation T is more liquid than Corporation W.
• Debt to assets ratio of Corporation T is 68.9% and free cash flow is $418,000,000. Debt to assets ratio of Corporation W is 60.1% and free cash flow is $7,902,000,000. Based on these two ratios, it can be inferred that the Corporation W is more solvent than Corporation T