Financial Statement Analysis & Valuation, 5e Easton, McAnally, Sommers, Zhang
(Solutions Manual All Chapters, 100% Original Verified, A+ Grade) All Chapters
Solutions Manual Supplement files download link at the end of this file.
Module 1
Framework for Analysis and Valuation
QUESTIONS
Q1-1. Organizations undertake four major activities: planning, financing, investing, and
operating. Financing is the means a company uses to pay for resources. Investing
refers to the buying and selling of resources necessary to carry out the organization’s
plans. Operating activities are the actual carrying out of these plans. Planning is the
glue that connects these activities, including the organization’s ideas, goals and
strategies. Financial accounting information provides valuable input into the planning
process, and, subsequently, reports on the results of plans so that corrective action
can be taken, if necessary.
Q1-2. An organization’s financing activities (liabilities and equity = sources of funds) pay for
investing activities (assets = uses of funds). An organization’s assets cannot be more
or less than its liabilities and equity combined. This means: assets = liabilities +
equity. This relation is called the accounting equation (sometimes called the balance
sheet equation), and it applies to all organizations at all times.
Q1-3. The four main financial statements are: income statement, balance sheet, statement
of stockholders’ equity, and statement of cash flows. The income statement provides
information about the company’s revenues, expenses and profitability over a period
of time. The balance sheet lists the company’s assets (what it owns), liabilities (what
it owes), and stockholders’ equity (the residual claims of its owners) as of a point in
time. The statement of stockholders’ equity reports on the changes to each
stockholders’ equity account during the period. The statement of cash flows identifies
the sources (inflows) and uses (outflows) of cash, that is, where the company got its
cash from and what it did with it. Together, the four statements provide a complete
picture of the financial condition of the company.
Q1-4. The balance sheet provides information that helps users understand a company’s
resources (assets) and claims to those resources (liabilities and stockholders’ equity)
as of a given point in time.
© Cambridge Business Publishers, 2018
Solutions Manual, Module 1 1-1
,Q1-5. The income statement covers a period of time. An income statement reports whether
the business has earned a net income (also called profit or earnings) or incurred a
net loss. Importantly, the income statement lists the types and amounts of revenues
and expenses making up net income or net loss.
Q1-6. The statement of cash flows reports on the cash inflows and outflows relating to a
company’s operating, investing, and financing activities over a period of time. The
sum of these three activities yields the net change in cash for the period. This
statement is a useful complement to the income statement, which reports on
revenues and expenses, but which conveys relatively little information about cash
flows.
Q1-7. Retained earnings (reported on the balance sheet) is increased each period by any
net income earned during the period (as reported in the income statement) and
decreased each period by the payment of dividends (as reported in the statement of
cash flows and the statement of stockholders’ equity). Transactions reflected on the
statement of cash flows link the previous period’s balance sheet to the current
period’s balance sheet. The ending cash balance appears on both the balance sheet
and the statement of cash flows.
Q1-8. External users and their uses of accounting information include: (a) lenders for
measuring the risk and return of loans; (b) shareholders for assessing the return and
risk in acquiring shares; and (c) analysts for assessing investment potential. Other
users are auditors, consultants, officers, directors for overseeing management,
employees for judging employment opportunities, regulators, unions, suppliers, and
appraisers.
Q1-9. Managers deal with a variety of information about their employers and customers
that is not generally available to the public. Ethical issues arise concerning the
possibility that managers might personally benefit by using confidential information.
There is also the possibility that their employers and/or customers might be harmed if
certain information is not kept confidential.
Q1-10. The five forces (according to Professor Michael Porter) are (A) industry competition,
(B) buyer power, (C) supplier power, (D) product substitutes, and (E) threat of entry.
Q1-11. W SWOT stands for Strengths and Weaknesses (both are internal factors)
Opportunities and Threats (both external factors).
Q1-12. Procter & Gamble’s independent auditor is Deloitte & Touche LLP. The auditor
expressly states that “our responsibility is to express an opinion on these financial
statements based on our audits.” The auditor also states that “these financial
statements are the responsibility of the company’s management.” Thus, the auditor
does not assume responsibility for the financial statements.
© Cambridge Business Publishers, 2018
1-2 Financial Statement Analysis & Valuation, 5th Edition
,Q1-13. While firms acknowledge the increasing need for more complete disclosure of
financial and nonfinancial information, they have resisted these demands to protect
their competitive position. Corporate executives must weigh the benefits they receive
from the financial markets as a result of more transparent and revealing financial
reporting against the costs of divulging proprietary information to competitors and
others.
Q1-14. Subsidiaries are not necessarily owned 100% -- control can usually be effectuated if
the parent owns more than 50%. When a non-wholly owned subsidiary earns
income, the total net income is apportioned between the parent (the controlling
interest) and the remainder (the non-controlling interest).
Q1-15. False. The parent includes 100% of the subsidiary’s revenue and expenses (line by
line) in order to calculate consolidated net income. Then, the 20% of the net income
that is attributable to the non-controlling interest, is reported separately. The effect is
to add 80% of the net income but not line by line as the question asks.
Q1-16. Oracle Corporation’s share of the reported consolidated net income of $9,017 million
is $8,901 million, which is included in retained earnings. The difference of $116
million is the non-controlling interest share of consolidated net income. That amount
is not “earned” by Oracle’s shareholders and therefore not included in retained
earnings.
Q1-17. Financial accounting information is frequently used in order to evaluate management
performance. The return on equity (ROE) and return on assets (ROA) provide useful
measures of financial performance as they combine elements from both the income
statement and the balance sheet. Financial accounting information is also frequently
used to monitor compliance with external contract terms. Banks often set limits on
such items as the amount of total liabilities in relation to stockholders’ equity or the
amount of dividends that a company may pay. Audited financial statements provide
information that can be used to monitor compliance with these limits (often called
covenants). Regulators and taxing authorities also utilize financial information to
monitor items of interest.
Q1-18. Managers are vitally concerned about disclosing proprietary information that might
benefit the company’s competitors. Of most concern, is the “cost” of losing some
competitive advantage. There traditionally has been tension between companies and
the financial professionals (especially investment analysts) who press firms for more
and more financial and nonfinancial information.
© Cambridge Business Publishers, 2018
Solutions Manual, Module 1 1-3
, Q1-19. Net income is an important measure of financial performance. It indicates that the
market values the company’s products or services, that is, it is willing to pay a price
for the products or services enough to cover the costs to bring them to market and to
provide the company’s investors with a profit. Net income does not tell the whole
story, however. A company can always increase its net income with additional
investment in something as simple as a bank savings account. A more meaningful
measure of financial performance comes from measuring the level of net income
relative to the investment made. One investment measure is the balance of
stockholders’ equity, and the comparison of net income to average stockholders’
equity (ROE) is a fundamental measure of financial performance.
Q1-20. Borrowed money must be repaid, both the principal amount borrowed, as well as
interest on the borrowed funds. These payments have contractual due dates. If
payments are not prompt, creditors have powerful legal remedies, including forcing
the company into bankruptcy. Consequently, when comparing two companies with
the same return on equity, the one using less debt would generally be viewed as a
safer (less risky) investment.
© Cambridge Business Publishers, 2018
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