Chapter 5, Problem 5.16P

To determine

Ratio analysis:

Ratio analysis is a tool to analyze the financial statements of a company which helps to express a mathematical relationship among the items of financial statements.

Balance Sheet:

Balance Sheet summarizes the assets, the liabilities, and the Shareholder’s equity of a company at a given date. It is also known as the statement of financial status of the business.

To prepare: The balance sheet of Company CC for the year ended December, 31 2016.

Answer to Problem 5.16P

The balance sheet of Company CC for the year ended December, 31 2016 is as follows:

Corporation CC
Balance Sheet
For the year ended December 31, 2016
Assets	Amount ($ in millions)	Amount ($ in millions)
Current assets:
Cash (7)	10
Accounts receivables (6)	20
Inventories (5)	30
Total current assets		60
Net property, plant, and equipment (9)		140
Total assets		200
Liabilities and Shareholders' Equity	Amount ($ in millions)	Amount ($ in millions)
Current liabilities (8)		30
Long-term liabilities (11)		70
Shareholders’ equity (10)		100
Total liabilities and shareholders’ equity		200

Table (1)

Explanation of Solution

Working notes: ($ in millions)

1. Calculate the value of net income

Given,

Interest expense is $2

Income tax expense $12

$\begin{array}{c}\text{Times interest earned ratio = }\frac{\text{Net income}+\text{Interest expense}+\text{Income tax expense}}{\text{Interest expense}}\\ 17\text{ = }\frac{\text{Net income}+\$2+\$12}{\$2}\\ 34=\text{ Net income}+\$14\\ \text{Net income = }\$34-\$14\\ \text{Net income = }\$20\end{array}$ (1)

2. Calculate the amount of average total assets

$\begin{array}{c}\text{Return on Assets = }\frac{\text{Net income (1)}}{\text{Average total assets}}\\ \text{10\% = }\frac{\$20}{\text{Average total assets}}\\ \text{Average total assets = }\frac{\$20}{\text{10}}\times 100\\ \text{Average total assets = }\$200\end{array}$ (2)

3. Calculate the amount of net sales

$\begin{array}{c}\text{Profit margin on sales = }\frac{\text{Net income}}{\text{Net sales}}\\ \text{5\% = }\frac{\$20}{\text{Net sales }}\\ \text{Net sales = }\frac{\$20}{5}\times 100\\ \text{Net sales = }\$400\end{array}$ (3)

4. Calculate the cost of goods sold

$\begin{array}{c}\text{Gross profit margin= }\frac{\text{Gross profit}}{\text{Net sales}}\\ \text{40\% = }\frac{\text{Gross profit}}{\text{400 }}\\ \text{Gross profit = \$4}00\times \frac{40}{100}\\ \text{Gross profit = }\$160\end{array}$

$\begin{array}{c}\text{Cost of goods sold = Net sales}-\text{ Gross profit}\\ \text{= \$400}-\$160\\ =\$240\end{array}$ (4)

5. Calculate the average inventories

$\begin{array}{c}\text{Inventory turnover ratio = }\frac{\text{Cost of goods sold}}{\text{Average inventories}}\\ 8\text{ = }\frac{\$240}{\text{Average inventories}}\\ \text{Average inventories}=\frac{\$240}{8}\\ \text{Average inventories}=\text{ \$30}\end{array}$ (5)

6. Calculate the receivable turnover ratio

$\begin{array}{c}\text{Receivables turnover ratio = }\frac{\text{Net sales }}{\text{Average receivables}}\\ \text{20 = }\frac{\$400}{\text{Average receivables}}\\ \text{Average receivables}=\frac{\$400}{20}\\ \text{Average receivables}=\text{ \$20}\end{array}$ (6)

7.  Calculate the amount of cash

$\begin{array}{c}\text{Current ratio }=\frac{\text{Current assets}}{\text{Current liablities}}\\ \frac{2}{1}=\frac{\text{Current assets}}{\text{Current liabilities}}\\ \text{Current assets}=2\text{ Current liabilities}\end{array}$ (a)

$\begin{array}{c}\text{Acid-test ratio =}\frac{\text{Quick assets}}{\text{Current liabilities}}\\ 1=\frac{\text{Quick assets}}{\text{Current liabilities}}\\ \frac{1}{1}=\frac{\text{Quick assets}}{\text{Current liabilities}}\\ \text{Current liabilities}=\text{Quick assets}\end{array}$ (b)

By using the above equation, determine amount of cash.

$\begin{array}{c}\text{Current assets }=\frac{2\text{ Quick assets}}{1}\\ \text{Cash}+\text{Receivables}+\text{Inventories }=\text{ 2}\times \left(\text{Cash}+\text{Receivables}\right)\\ \text{Cash}+\text{Receivables}+\text{Inventories }=2\text{Cash}+2\text{Receivables}\\ \text{Inventories }=2\text{Cash}+2\text{Receivables}-\text{Cash}-\text{Receivables}\end{array}$

$\begin{array}{c}\text{Inventories }=\text{ Cash }+\text{ Receivables}\\ \text{Cash }=\text{Inventories }-\text{Receivables}\\ \text{Cash }=\$30-\$20\\ \text{Cash }=\$10\end{array}$ (7)

8. Calculate the amount of current liabilities

$\begin{array}{c}\text{Acid-test ratio =}\frac{\text{Quick assets}}{\text{Current liabilities}}\\ \frac{1}{1}=\frac{\left(\text{Cash}+\text{Receivables}\right)}{\text{Current liabilities}}\\ 1=\frac{\left(\$10+\$20\right)}{\text{Current liabilities}}\\ 1=\frac{\$30}{\text{Current liabilities}}\end{array}$

$\text{Current liabilities = }\$30$ (8)

9. Calculate the amount of non-current assets

$\begin{array}{c}\text{Non-current assets = Total assets}-\text{ Current assets}\\ \text{Non-current assets = \$200}-\left(\text{Cash}+\text{Receivables}+\text{Inventories}\right)\\ \text{Non-current assets = \$200}-\left(\$10+\$20+\$30\right)\\ \text{Non-current assets = \$200}-\text{ \$60}\end{array}$

$\text{Non-current assets = \$140}$ (9)

10. Calculate the amount of average shareholders’ equity

$\begin{array}{c}\text{Return on shareholders' equity = }\frac{\text{Net income}}{\text{Average shareholders' equity}}\\ \text{20\% = }\frac{\$20}{\text{Average shareholders' equity }}\\ \text{Average shareholders' equity = }\frac{\$20}{20}\times 100\\ \text{Average shareholders' equity = }\$100\end{array}$ (10)

11.  Calculate the amount of long-term liabilities

$\begin{array}{c}\text{Debt equtiy ratio =}\frac{\text{Total liabilities}}{\text{Total shareholders' equity}}\\ 1=\frac{\text{Total liabilities}}{\$100}\\ \text{Total liabilities}=\$100\end{array}$

$\begin{array}{c}\text{Long term liabilities = Total liabilities}-\text{Current liabilities}\\ \text{= \$100}-\$30\\ =\$70\end{array}$ (11)

Conclusion

Hence, the total amount of balance sheet is $200 million.