Chapter 16
Financial Statement Analysis
Solutions to Questions
16-1 Horizontal analysis examines how a other source of return on an investment in stock
particular item on a financial statement such as is increases in market value.
sales or cost of goods sold behaves over time.
Vertical analysis involves analysis of items on an 16-6 Financial leverage results from borrowing
income statement or balance sheet for a single funds at an interest rate that differs from the
period. In vertical analysis of the income rate of return on assets acquired using those
statement, all items are typically stated as a funds. If the rate of return on the assets is
percentage of sales. In vertical analysis of the higher than the interest rate at which the funds
balance sheet, all items are typically stated as a were borrowed, financial leverage is positive and
percentage of total assets. stockholders gain. If the return on the assets is
lower than the interest rate, financial leverage is
16-2 By looking at trends, an analyst hopes to negative and the stockholders lose.
get some idea of whether a situation is
improving, remaining the same, or deteriorating. 16-7 If the company experiences big
Such analyses can provide insight into what is variations in net cash flows from operations,
likely to happen in the future. Rather than stockholders might be pleased that the company
looking at trends, an analyst may compare one has no debt. In hard times, interest payments
company to another or to industry averages might be very difficult to meet.
using common-size financial statements. On the other hand, if investments within
the company can earn a rate of return that
16-3 Price-earnings ratios reflect investors’ exceeds the interest rate on debt, stockholders
expectations concerning future earnings. The would get the benefits of positive leverage if the
higher the price-earnings ratio, the greater the company took on debt.
growth in earnings investors expect. For this
reason, two companies might have the same 16-8 No. The market value of a share of
current earnings and yet have quite different common stock often exceeds the book value per
price-earnings ratios. By definition, a stock with share. Book value represents the cumulative
current earnings of $4 and a price-earnings ratio effects on the balance sheet of past activities,
of 20 would be selling for $80 per share. evaluated using historical prices. The market
value of the stock reflects investors’
16-4 A rapidly growing tech company would expectations about the company’s future
probably have many opportunities to make earnings. For most companies, market value
investments at a rate of return higher than exceeds book value because investors anticipate
stockholders could earn in other investments. It future earnings growth.
would be better for the company to invest in
such opportunities than to pay out dividends 16-9 A 2 to 1 current ratio might not be
and thus one would expect the company to have adequate for several reasons. First, the
a low dividend payout ratio. composition of the current assets may be
heavily weighted toward slow-turning and
16-5 The dividend yield is the dividend per difficult-to-liquidate inventory, or the inventory
share divided by the market price per share. The may contain large amounts of obsolete goods.
Second, the receivables may be low quality,
Copyright © 2024 McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior
written consent of McGraw Hill LLC.
Managerial Accounting 18th Edition, Solutions Manual, Chapter 16
,including large amounts of accounts that may be
difficult to collect.
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent
of McGraw Hill LLC.
Managerial Accounting 18th Edition, Solutions Manual, Chapter 16 437
,The Foundational 15
1. The earnings per share is computed as follows:
Net income
Earnings per share
= Average number of common
shares outstanding
$92,400
= = $0.77 per share
120,000
shares*
* $120,000 ÷ $1 par value per share = 120,000 shares
2. The price-earnings ratio is computed as follows:
Market price per share
Price-earnings ratio =
Earnings per share
$2.75
= = 3.57 (rounded)
$0.77
3. The dividend payout ratio is computed as follows:
Dividends per share
Dividend payout ratio =
Earnings per share
$0.55
= = 71% (rounded)
$0.77
The dividend yield ratio is computed as follows:
Dividends per share
Dividend yield ratio =
Market price per share
$0.55
= = 20%
$2.75
, © The McGraw-Hill Companies, Inc., 2018. All rights reserved.
438 Managerial Accounting, 16th Edition
Financial Statement Analysis
Solutions to Questions
16-1 Horizontal analysis examines how a other source of return on an investment in stock
particular item on a financial statement such as is increases in market value.
sales or cost of goods sold behaves over time.
Vertical analysis involves analysis of items on an 16-6 Financial leverage results from borrowing
income statement or balance sheet for a single funds at an interest rate that differs from the
period. In vertical analysis of the income rate of return on assets acquired using those
statement, all items are typically stated as a funds. If the rate of return on the assets is
percentage of sales. In vertical analysis of the higher than the interest rate at which the funds
balance sheet, all items are typically stated as a were borrowed, financial leverage is positive and
percentage of total assets. stockholders gain. If the return on the assets is
lower than the interest rate, financial leverage is
16-2 By looking at trends, an analyst hopes to negative and the stockholders lose.
get some idea of whether a situation is
improving, remaining the same, or deteriorating. 16-7 If the company experiences big
Such analyses can provide insight into what is variations in net cash flows from operations,
likely to happen in the future. Rather than stockholders might be pleased that the company
looking at trends, an analyst may compare one has no debt. In hard times, interest payments
company to another or to industry averages might be very difficult to meet.
using common-size financial statements. On the other hand, if investments within
the company can earn a rate of return that
16-3 Price-earnings ratios reflect investors’ exceeds the interest rate on debt, stockholders
expectations concerning future earnings. The would get the benefits of positive leverage if the
higher the price-earnings ratio, the greater the company took on debt.
growth in earnings investors expect. For this
reason, two companies might have the same 16-8 No. The market value of a share of
current earnings and yet have quite different common stock often exceeds the book value per
price-earnings ratios. By definition, a stock with share. Book value represents the cumulative
current earnings of $4 and a price-earnings ratio effects on the balance sheet of past activities,
of 20 would be selling for $80 per share. evaluated using historical prices. The market
value of the stock reflects investors’
16-4 A rapidly growing tech company would expectations about the company’s future
probably have many opportunities to make earnings. For most companies, market value
investments at a rate of return higher than exceeds book value because investors anticipate
stockholders could earn in other investments. It future earnings growth.
would be better for the company to invest in
such opportunities than to pay out dividends 16-9 A 2 to 1 current ratio might not be
and thus one would expect the company to have adequate for several reasons. First, the
a low dividend payout ratio. composition of the current assets may be
heavily weighted toward slow-turning and
16-5 The dividend yield is the dividend per difficult-to-liquidate inventory, or the inventory
share divided by the market price per share. The may contain large amounts of obsolete goods.
Second, the receivables may be low quality,
Copyright © 2024 McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior
written consent of McGraw Hill LLC.
Managerial Accounting 18th Edition, Solutions Manual, Chapter 16
,including large amounts of accounts that may be
difficult to collect.
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent
of McGraw Hill LLC.
Managerial Accounting 18th Edition, Solutions Manual, Chapter 16 437
,The Foundational 15
1. The earnings per share is computed as follows:
Net income
Earnings per share
= Average number of common
shares outstanding
$92,400
= = $0.77 per share
120,000
shares*
* $120,000 ÷ $1 par value per share = 120,000 shares
2. The price-earnings ratio is computed as follows:
Market price per share
Price-earnings ratio =
Earnings per share
$2.75
= = 3.57 (rounded)
$0.77
3. The dividend payout ratio is computed as follows:
Dividends per share
Dividend payout ratio =
Earnings per share
$0.55
= = 71% (rounded)
$0.77
The dividend yield ratio is computed as follows:
Dividends per share
Dividend yield ratio =
Market price per share
$0.55
= = 20%
$2.75
, © The McGraw-Hill Companies, Inc., 2018. All rights reserved.
438 Managerial Accounting, 16th Edition
