, b. Dividend Income = $25 x 250 = $6,250 x 31.71% = Tax on Dividend Income = $1,981.88
After tax income = $25(250) – $1,981.88 = $4,268.12
c. Combined Federal & Provincial tax on capital gain = $15(500)(0.24) = $1,800
After tax income = $7,500 - $1,800 = $5,700
OR Federal $15(500)(0.5)(0.33) = $1,237.5 + Provincial $15(500)(0.5)(0.15) = $5625 = $1,800
taxes
After tax income = $7,500 – $1,800 = $5,700
34. (LO4) Carry the ($600) loss in 2017 back 3 years and the remaining loss is carried forward 7
years: (in 1,000's) total carry backs = $116 + $140 + $168 = $424 leaving $176 ($600 – $424) to
carry forward which effectively reduces taxable income to zero for all years through 2020. At that
time, remaining carry-forward is $56.
35. (LO5)
a.
Year UCC CCA End UCC
1 99,200 44,640 54,560
2 54,560 16,368 38,192
3 38,192 11,458 26,734
4 26,734 8,020 18,714
5 18,714 5,614 13,100
b. Since the asset has no value and the asset pool remains open, there are no tax consequences.
CHAPTER 3
WORKING WITH FINANCIAL
STATEMENTS
Learning Objectives
LO1 The sources and uses of a firm‘s cash flows.
LO2 How to standardize financial statements for comparison purposes.
LO3 How to compute and, more importantly, interpret some common ratios.
LO4 The determinants of a firm‘s profitability.
LO5 Some of the problems and pitfalls in financial statement analysis.
Answers to Concepts Review and Critical Thinking Questions
1. (LO2)
a. If inventory is purchased with cash, then there is no change in the current ratio. If inventory is
purchased on credit, then there is a decrease in the current ratio if it was initially greater than 1.0.
b. Reducing accounts payable with cash increases the current ratio if it was initially greater than 1.0.
c. Reducing short-term debt with cash increases the current ratio if it was initially greater than 1.0.
Ross et al, Fundamentals of Corporate Finance 11th Canadian Edition Solutions Manual
© 2022 McGraw-Hill Education Ltd.
7-15 dr.j
, d. As long-term debt approaches maturity, the principal repayment and the remaining interest
expense become current liabilities. Thus, if debt is paid off with cash, the current ratio increases
if it was initially greater than 1.0. If the debt has not yet become a current liability, then paying it
off will reduce the current ratio since current liabilities are not affected.
e. Reduction of accounts receivables and an increase in cash leaves the current ratio unchanged.
f. Inventory sold at cost reduces inventory and raises cash, so the current ratio is unchanged.
g. Inventory sold for a profit raises cash in excess of the inventory recorded at cost, so the current
ratio increases.
2. (LO2) The firm has increased inventory relative to other current assets; therefore, assuming current
liability levels remain unchanged, liquidity has potentially decreased.
3. (LO2) A current ratio of 0.50 means that the firm has twice as much in current liabilities as it does in
current assets; the firm potentially has poor liquidity. If pressed by its short-term creditors and
suppliers for immediate payment, the firm might have a difficult time meeting its obligations. A
current ratio of 1.50 means the firm has 50% more current assets than it does current liabilities. This
probably represents an improvement in liquidity; short-term obligations can generally be met
completely with a safety factor built in. A current ratio of 15.0, however, might be excessive. Any
excess funds sitting in current assets generally earn little or no return. These excess funds might be
put to better use by investing in productive long-term assets or distributing the funds to shareholders.
4. (LO2)
a. Quick ratio provides a measure of the short-term liquidity of the firm, after removing the effects
of inventory, generally the least liquid of the firm‘s current assets.
b. Cash ratio represents the ability of the firm to completely pay off its current liabilities with its
most liquid asset (cash).
c. Interval measure estimates how long a company could continue operating by depleting its
existing current assets at a rate that is consistent with its average daily operating costs.
d. Total asset turnover measures how much in sales is generated by each dollar of firm assets.
e. Equity multiplier represents the degree of leverage for an equity investor of the firm; it measures
the dollar worth of firm assets each equity dollar has a claim to.
f. Long-term debt ratio measures the percentage of total firm capitalization funded by long-term
debt.
g. Times interest earned ratio provides a relative measure of how well the firm‘s operating earnings
can cover current interest obligations.
h. Profit margin is the accounting measure of bottom-line profit per dollar of sales.
i. Return on assets is a measure of bottom-line profit per dollar of total assets.
j. Return on equity is a measure of bottom-line profit per dollar of equity.
k. Price-earnings ratio reflects how much value per share the market places on a dollar of
accounting earnings for a firm.
5. (LO1) Common size financial statements express all balance sheet accounts as a percentage of total
assets and all income statement accounts as a percentage of total sales. Using these percentage values
rather than nominal dollar values facilitates comparisons between firms of different size or business
type. Common-base year financial statements express each account as a ratio between their current
year nominal dollar value and some reference year nominal dollar value. Using these ratios allows the
total growth trend in the accounts to be measured.
6. (LO2) Peer group analysis involves comparing the financial ratios and operating performance of a
particular firm to a set of peer group firms in the same industry or line of business. Comparing a firm
to its peers allows the financial manager to evaluate whether some aspects of the firm‘s operations,
finances, or investment activities are out of line with the norm, thereby providing some guidance on
appropriate actions to take to adjust these ratios if appropriate. An aspirant group would be a set of
firms whose performance the company in question would like to emulate. The financial manager
often uses the financial ratios of aspirant groups as the target ratios for his or her firm; some managers
are evaluated by how well they match the performance of an identified aspirant group.
Ross et al, Fundamentals of Corporate Finance 11th Canadian Edition Solutions Manual
© 2022 McGraw-Hill Education Ltd.
7-16 dr.j
, 7. (LO3) Return on equity is probably the most important accounting ratio that measures the bottom-line
performance of the firm with respect to the equity shareholders. The Du Pont identity emphasizes the
role of a firm‘s profitability, asset utilization efficiency, and financial leverage in achieving an ROE
figure. For example, a firm with ROE of 20% would seem to be doing well, but this figure may be
misleading if it were marginally profitable (low profit margin) and highly levered (high equity
multiplier). If the firm‘s margins were to erode slightly, the ROE would be heavily impacted.
8. (LO2) The book-to-bill ratio is intended to measure whether demand is growing or falling. It is
closely followed because it is a barometer for the entire high-tech industry where levels of revenues
and earnings have been relatively volatile.
9. (LO2) If a company is growing by opening new stores, then presumably total revenues would be
rising. Comparing total sales at two different points in time might be misleading. Same-store sales
control for this by only looking at revenues of stores open within a specific period.
10. (LO1)
a. For an electric utility such as Ontario Hydro, expressing costs on a per kilowatt hour basis would
be a way to compare costs with other utilities of different sizes.
b. For a retailer such as Sears, expressing sales on a per square foot basis would be useful in
comparing revenue production against other retailers.
c. For an airline such as Air Canada, expressing costs on a per passenger mile basis allows for
comparisons with other airlines by examining how much it costs to fly one passenger one mile.
d. For an on-line service provider such as Bell Internet, using a per call basis for costs would allow
for comparisons with smaller services. A per subscriber basis would also make sense.
e. For a hospital such as Toronto General, revenues and costs expressed on a per bed basis would be
useful.
f. For a university textbook publisher such as McGraw-Hill Ryerson, the leading publisher of
finance textbooks for the university market, the obvious standardization would be per book sold.
11. (LO1) Reporting the sale of Treasury securities as cash flow from operations is an accounting ―trick‖,
and as such, should constitute a possible red flag about the companies accounting practices. For most
companies, the gain from a sale of securities should be placed in the financing section. Including the
sale of securities in the cash flow from operations would be acceptable for a financial company, such
as an investment or commercial bank.
12. (LO1) Increasing the payables period increases the cash flow from operations. This could be
beneficial for the company as it may be a cheap form of financing, but it is basically a one time
change. The payables period cannot be increased indefinitely as it will negatively affect the
company‘s credit rating if the payables period becomes too long.
Solutions to Questions and Problems
NOTE: End of chapter problems were solved using a spreadsheet. Many problems require multiple steps.
Due to space and readability constraints, when these intermediate steps are included in this solutions
manual, rounding may appear to have occurred. However, the final answer for each problem is found
without rounding during any step in the problem.
Basic
1. (LO3) Using the formula for NWC, we get:
NWC = CA – CL
CA = CL + NWC = $3,950 + 2,710 = $6,660
Ross et al, Fundamentals of Corporate Finance 11th Canadian Edition Solutions Manual
© 2022 McGraw-Hill Education Ltd.
7-17 dr.j
After tax income = $25(250) – $1,981.88 = $4,268.12
c. Combined Federal & Provincial tax on capital gain = $15(500)(0.24) = $1,800
After tax income = $7,500 - $1,800 = $5,700
OR Federal $15(500)(0.5)(0.33) = $1,237.5 + Provincial $15(500)(0.5)(0.15) = $5625 = $1,800
taxes
After tax income = $7,500 – $1,800 = $5,700
34. (LO4) Carry the ($600) loss in 2017 back 3 years and the remaining loss is carried forward 7
years: (in 1,000's) total carry backs = $116 + $140 + $168 = $424 leaving $176 ($600 – $424) to
carry forward which effectively reduces taxable income to zero for all years through 2020. At that
time, remaining carry-forward is $56.
35. (LO5)
a.
Year UCC CCA End UCC
1 99,200 44,640 54,560
2 54,560 16,368 38,192
3 38,192 11,458 26,734
4 26,734 8,020 18,714
5 18,714 5,614 13,100
b. Since the asset has no value and the asset pool remains open, there are no tax consequences.
CHAPTER 3
WORKING WITH FINANCIAL
STATEMENTS
Learning Objectives
LO1 The sources and uses of a firm‘s cash flows.
LO2 How to standardize financial statements for comparison purposes.
LO3 How to compute and, more importantly, interpret some common ratios.
LO4 The determinants of a firm‘s profitability.
LO5 Some of the problems and pitfalls in financial statement analysis.
Answers to Concepts Review and Critical Thinking Questions
1. (LO2)
a. If inventory is purchased with cash, then there is no change in the current ratio. If inventory is
purchased on credit, then there is a decrease in the current ratio if it was initially greater than 1.0.
b. Reducing accounts payable with cash increases the current ratio if it was initially greater than 1.0.
c. Reducing short-term debt with cash increases the current ratio if it was initially greater than 1.0.
Ross et al, Fundamentals of Corporate Finance 11th Canadian Edition Solutions Manual
© 2022 McGraw-Hill Education Ltd.
7-15 dr.j
, d. As long-term debt approaches maturity, the principal repayment and the remaining interest
expense become current liabilities. Thus, if debt is paid off with cash, the current ratio increases
if it was initially greater than 1.0. If the debt has not yet become a current liability, then paying it
off will reduce the current ratio since current liabilities are not affected.
e. Reduction of accounts receivables and an increase in cash leaves the current ratio unchanged.
f. Inventory sold at cost reduces inventory and raises cash, so the current ratio is unchanged.
g. Inventory sold for a profit raises cash in excess of the inventory recorded at cost, so the current
ratio increases.
2. (LO2) The firm has increased inventory relative to other current assets; therefore, assuming current
liability levels remain unchanged, liquidity has potentially decreased.
3. (LO2) A current ratio of 0.50 means that the firm has twice as much in current liabilities as it does in
current assets; the firm potentially has poor liquidity. If pressed by its short-term creditors and
suppliers for immediate payment, the firm might have a difficult time meeting its obligations. A
current ratio of 1.50 means the firm has 50% more current assets than it does current liabilities. This
probably represents an improvement in liquidity; short-term obligations can generally be met
completely with a safety factor built in. A current ratio of 15.0, however, might be excessive. Any
excess funds sitting in current assets generally earn little or no return. These excess funds might be
put to better use by investing in productive long-term assets or distributing the funds to shareholders.
4. (LO2)
a. Quick ratio provides a measure of the short-term liquidity of the firm, after removing the effects
of inventory, generally the least liquid of the firm‘s current assets.
b. Cash ratio represents the ability of the firm to completely pay off its current liabilities with its
most liquid asset (cash).
c. Interval measure estimates how long a company could continue operating by depleting its
existing current assets at a rate that is consistent with its average daily operating costs.
d. Total asset turnover measures how much in sales is generated by each dollar of firm assets.
e. Equity multiplier represents the degree of leverage for an equity investor of the firm; it measures
the dollar worth of firm assets each equity dollar has a claim to.
f. Long-term debt ratio measures the percentage of total firm capitalization funded by long-term
debt.
g. Times interest earned ratio provides a relative measure of how well the firm‘s operating earnings
can cover current interest obligations.
h. Profit margin is the accounting measure of bottom-line profit per dollar of sales.
i. Return on assets is a measure of bottom-line profit per dollar of total assets.
j. Return on equity is a measure of bottom-line profit per dollar of equity.
k. Price-earnings ratio reflects how much value per share the market places on a dollar of
accounting earnings for a firm.
5. (LO1) Common size financial statements express all balance sheet accounts as a percentage of total
assets and all income statement accounts as a percentage of total sales. Using these percentage values
rather than nominal dollar values facilitates comparisons between firms of different size or business
type. Common-base year financial statements express each account as a ratio between their current
year nominal dollar value and some reference year nominal dollar value. Using these ratios allows the
total growth trend in the accounts to be measured.
6. (LO2) Peer group analysis involves comparing the financial ratios and operating performance of a
particular firm to a set of peer group firms in the same industry or line of business. Comparing a firm
to its peers allows the financial manager to evaluate whether some aspects of the firm‘s operations,
finances, or investment activities are out of line with the norm, thereby providing some guidance on
appropriate actions to take to adjust these ratios if appropriate. An aspirant group would be a set of
firms whose performance the company in question would like to emulate. The financial manager
often uses the financial ratios of aspirant groups as the target ratios for his or her firm; some managers
are evaluated by how well they match the performance of an identified aspirant group.
Ross et al, Fundamentals of Corporate Finance 11th Canadian Edition Solutions Manual
© 2022 McGraw-Hill Education Ltd.
7-16 dr.j
, 7. (LO3) Return on equity is probably the most important accounting ratio that measures the bottom-line
performance of the firm with respect to the equity shareholders. The Du Pont identity emphasizes the
role of a firm‘s profitability, asset utilization efficiency, and financial leverage in achieving an ROE
figure. For example, a firm with ROE of 20% would seem to be doing well, but this figure may be
misleading if it were marginally profitable (low profit margin) and highly levered (high equity
multiplier). If the firm‘s margins were to erode slightly, the ROE would be heavily impacted.
8. (LO2) The book-to-bill ratio is intended to measure whether demand is growing or falling. It is
closely followed because it is a barometer for the entire high-tech industry where levels of revenues
and earnings have been relatively volatile.
9. (LO2) If a company is growing by opening new stores, then presumably total revenues would be
rising. Comparing total sales at two different points in time might be misleading. Same-store sales
control for this by only looking at revenues of stores open within a specific period.
10. (LO1)
a. For an electric utility such as Ontario Hydro, expressing costs on a per kilowatt hour basis would
be a way to compare costs with other utilities of different sizes.
b. For a retailer such as Sears, expressing sales on a per square foot basis would be useful in
comparing revenue production against other retailers.
c. For an airline such as Air Canada, expressing costs on a per passenger mile basis allows for
comparisons with other airlines by examining how much it costs to fly one passenger one mile.
d. For an on-line service provider such as Bell Internet, using a per call basis for costs would allow
for comparisons with smaller services. A per subscriber basis would also make sense.
e. For a hospital such as Toronto General, revenues and costs expressed on a per bed basis would be
useful.
f. For a university textbook publisher such as McGraw-Hill Ryerson, the leading publisher of
finance textbooks for the university market, the obvious standardization would be per book sold.
11. (LO1) Reporting the sale of Treasury securities as cash flow from operations is an accounting ―trick‖,
and as such, should constitute a possible red flag about the companies accounting practices. For most
companies, the gain from a sale of securities should be placed in the financing section. Including the
sale of securities in the cash flow from operations would be acceptable for a financial company, such
as an investment or commercial bank.
12. (LO1) Increasing the payables period increases the cash flow from operations. This could be
beneficial for the company as it may be a cheap form of financing, but it is basically a one time
change. The payables period cannot be increased indefinitely as it will negatively affect the
company‘s credit rating if the payables period becomes too long.
Solutions to Questions and Problems
NOTE: End of chapter problems were solved using a spreadsheet. Many problems require multiple steps.
Due to space and readability constraints, when these intermediate steps are included in this solutions
manual, rounding may appear to have occurred. However, the final answer for each problem is found
without rounding during any step in the problem.
Basic
1. (LO3) Using the formula for NWC, we get:
NWC = CA – CL
CA = CL + NWC = $3,950 + 2,710 = $6,660
Ross et al, Fundamentals of Corporate Finance 11th Canadian Edition Solutions Manual
© 2022 McGraw-Hill Education Ltd.
7-17 dr.j
