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FSA CHAP 8

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FSA CHAP 8 Powered By Docstoc
					                                           Chapter 8
                                          Profitability

    TO THE NET

    1. a. SIC 7370 Services – Computer Programming, Data Processing, Etc.

       b. Item 1 business
          Google is a global technology leader focused on improving the ways people
          connect with information.

       c.
                                          2004            2005       2006
            Revenue                       100.0           192.5      332.5
            Income from operations        100.0           315.1      554.5
            Net income                    100.0           367.2      771.1

       d. These are gigantic numbers. The issue will be when will these numbers subside.

    2. a. SIC 2000 Food and Kindred Products
       b. Item 1 Business
          The Company
          Flower Foods is one of the largest producers and marketers of bakery products
          in the United States.
       c.
                             Flower Foods, Inc. and Subsidiaries
                          Consolidated Statements of Income (in part)

                                                            For the 52 weeks ended

                                                December 30,      December 31,       January 1,
(Amounts in thousands)                             2006              2005               2005
Sales                                            $ 1,888,654       $ 1,715,869       $ 1,551,308
Materials, supplies, labor and other
  production costs (exclusive of depreciation
  and amortization, shown separately below)           949,612           861,583         779,437
Selling, marketing, and administrative
  expenses                                            759,387           695,656         632,895
Depreciation and amortization                          64,250            59,344          56,702
Income from operations                                118,493            99,286          82,274




                                                217
   d.
                             Flower Foods, Inc. and Subsidiaries
                          Consolidated Statements of Income (in part)
                              Horizontal Common-Size Analysis

                                                    For the 52 weeks ended
                                        December 30,      December 31,     January 1,
                                           2006               2005           2005
  Sales                                    121.7              110.6          100.0
  Materials, supplies, labor and
    other production costs
    (exclusive of depreciation
    and amortization, shown
    separately below)                       121.8              110.5            100.0
  Selling, marketing and
    administrative expenses                 120.0              109.9            100.0
  Depreciation and amortization             113.3              104.7            100.0
  Income from operations                    144.0              120.7            100.0


   e. These years are comparable, each years has 52 weeks.

   f. All items increased materially, except for depreciation and amortization. Income
      from operations increased materially more than the other items.

3. a. 1. SIC 3674 – Semiconductors & Related Devices

        2. Item 1 Business
           Industry
           We are the world’s largest semiconductor chip maker, based on revenue.

        3.
                                       Intel Corporation
                          Consolidated Statements of Income (in part)
                           Three Years Ended December 30, 2006

              (In Millions)             2006(1)      2005          2004
              Net revenue              $35,382      $38,826       $34,209
              Cost of sales             17,164       15,777        14,463
              Gross margin              18,218       23,049        19,746
              Operating income           5,652       12,090        10,130
             (1)
                   Cost of sales and operating expenses for the year ended December 31,
                   2006 include share-based compensation.




                                              218
  b. 1. SIC 3674 – Semiconductors & Related Devices

     2. Item 1 Business
        General
        We are a global semiconductor company with facilities around the world.

     3.
                           Advanced Micro Devices, Inc.
                   Consolidated Statement of Operations (in part)
                        Three Years Ended December 31, 2006

          (In thousands)             2006            2005           2004
          Total net revenue          $5,649          $5,848         $5,001
          Cost of sales               2,856           3,456          3,033
          Gross margin                2,793           2,392          1,968
          Operating income (loss)       (47)            232            222


  c. Intel appears to have preformed better. Operating income declined materially for
     Intel but it did not go into a loss.

     There are some good indications for Advanced Micro Devices., especially the
     increase in gross margin. The increase in gross margin would be a cause for
     picking Micro Devices.

4. a. 1. SIC 3711 Motor Vehicles & Passenger Car Bodies

     2.
                      Ford Motor Company and Subsidiaries
                     Consolidated Statement of Income (in part)
             For the Years Ended December 31, 2006, 2005, and 2004
                                    (In millions)

                 For the Years Ended December 31, 2006, 2005, and 2004
                   (in millions)            2006            2005         2004
     Automotive:
     Sales                                 $143,307       $153,474     $147,119
     Total cost and expenses                161,228        157,662      147,319
     Operating Income (loss)                 (17,921)        (4,188)       (200)
     Financial services:
     Revenues                                 16,816        23,422       25,197
     Total costs and expenses                 14,850        19,564       20,910
     Income/(loss) before income taxes-
       financial services                      1,966          4,953       4,287




                                        219
   3. The trend is very negative for both automotive and financial services.
      Financial services did maintain a profit while automotive had losses in billions.

b. 1. SIC 3711 Motor Vehicles & Passenger Car Bodies

   2.
                   General Motors Corporation and Subsidiaries
                      Consolidated Statement of Operations
                  (Dollars in millions, except per share amounts)

                                                2006              2005          2004
Net sales and revenues:
Automotive sales                               $172,927       $160,228        $163,341
Financial services and insurance
  revenues                                       34,422           34,427        32,010
Total net sales and revenues                    207,349          194,655       195,351
Cost and expenses:
Automotive cost of sales                        164,682          158,887       152,115
Selling, general, and administrative
  expenses                                       25,081           27,513        25,969
Interest expense                                 16,945           15,607        11,913
Provisions for credit and insurance losses
  related to financing and insurance
  operations                                       4,071            3,430        4,315
Other expenses                                     4,238            7,024        1,584
Total costs and expenses                        215,017          212,461       194,896
Operating loss                                    (7,668)         (17,806)        (545)


   3. Automotive
                                                   2006            2005         2004
        Automotive sales                         $ 172,927       $ 160,228    $ 163,341
        Automotive cost of sales                   164,682         158,887      152,115
        Gross profit                             $ 8,245         $ 1,341      $ 11,226

        Trend is negative on gross profit.

        Revenue:
        Financial services and insurance revenues      $34,422      $34,427    $32,010

        A modest increase in revenue. The trend was not good for either automotive
        or financial services and insurance revenues.

c. Neither performed good. General Motors performed better because its loss was
   much less than the Ford loss. Also, General Motors is a much bigger company
   than Ford.


                                         220
QUESTIONS

8- 1. Profits can be compared to the sales from which they are the residual. They can
      be compared to the assets that generate sales. Or, they can be viewed as return
      to the owner. Each measure looks at profits differently. The trends might move
      in different directions, depending on the base.

8- 2. Extraordinary items are by nature nonrecurring. They should be segregated in
      order to concentrate on profit that will be expected in the next period. Recurring
      earnings should be used in trend analysis of profitability.

8- 3. Expenses as a percent of sales must have increased if profits as a percent of
      sales declined.

8- 4. Profit margin in jewelry is usually much higher than in groceries. Groceries
      generate total profits based on volume of sales rather than high markup.

8- 5. A drop in profits or a rise in the asset base could cause a decline in the ratio. For
      example, higher cost of sales could cause a decline; or, a substantial investment
      in fixed assets that are not yet fully utilized could cause a decline.

8- 6. DuPont analysis relates return on assets to turnover and margin. It allows for
      further analysis of return on assets by this breakdown.

8- 7. Operating income is sales minus cost of sales and operating expenses. It does
      not include nonoperating items, such as other income, interest, and taxes.
      Operating assets are basically current assets plus plant, property, and
      equipment. They do not include investments, intangibles, and other assets.

       Removing non-operating items from the DuPont analysis gives a clearer picture
       of productive operations.

8- 8. Equity earnings are the owner’s proportionate share of the nonconsolidated
      subsidiary earnings. These earnings are usually greater than the cash from
      dividends from the nonconsolidated subsidiary.

8- 9. Return on assets is a function of net profit margin and total asset turnover.
      Return on assets could decline, given an increase in net profit margin, if the total
      asset turnover declined sufficiently.




                                           221
8-10. Return on investment measures return to all long-term supplies of funds. It
      includes net income plus tax-adjusted interest in the numerator and all long-term
      funds in the denominator. Return on total equity is just return to shareholders.

       Return on common equity is return only to common shareholders. Net income is
       reduced by preferred dividends in the numerator, and only common equity is in
       the denominator.

8-11. Return on investment is a profitability measure comparing income to capital
      utilized by the firm. Some measures are return on assts, return on equity, or
      income available to all capital sources, divided by capital. The given ratio is
      preferred, since it measures the profit available to all long-term sources of capital
      against that capital. The interest is multiplied by the tax adjustment factor to put
      interest on an after-tax basis.

8-12. This cannot be determined based only upon the absolute measures. It is
      necessary to compare these dollar figures to a base, such as investment or
      sales. Also, it is necessary to know if nonrecurring items are part of the firm’s
      income picture.

8-13. Interim reports are less reliable because they are not audited, but they can be
      very meaningful in indicating trends before the end of the year.

8-14. An objective considered here is timeliness rather than completeness. Full
      statements would take too long and involve too much cost to produce.

8-15. Comprehensive income includes net changes in (a) foreign currency translation
      adjustments, (b) unrealized holding gains and losses on available-for-sale
      marketable securities, and (c) changes to stockholders’ equity resulting from
      additional minimum pension liability adjustment. These items will tend to
      fluctuate more than other income items.

8-16. Pro forma financial information is hypothetical or a projected amount. Used
      improperly pro forma financial information can be a negative contribution to
      financial reporting.




                                            222
    PROBLEMS

PROBLEM 8-1

                              Net Income Before Minority Share of
                                  Earnings, Equity Income and
   Net Profit Margin      =
                                      Nonrecurring Items
                                           Net Sales

                                     2007               2006
                                   $52,500            $40,000
                                  $1,050,000         $1,000,000

                                   = 5.00%                = 4.00%

                              Net Income Before Minority Share of
   Return on Assets       =    Earnings and Nonrecurring Items
                                     Average Total Assets


                                     2007               2006
                                    $52,500            $40,000
                                   $230,000           $200,000

                                   = 22.83%          = 20.00%

                                        Net Sales
   Total Asset Turnover       =
                                   Average Total Assets

                                     2007               2006
                                  $1,050,000         $1,000,000
                                   $230,000           $200,000

                                  =4.57 times        =5.00 times
                                   per year           per year


                                        Net Income Before Nonrecurring
   Return on Common Equity          =     Items – Preferred Dividends
                                            Average Common Equity

                                     2007               2006
                                   $52,500            $40,000
                                   $170,000           $160,000

                                   = 30.88%           = 25.00%


                                             223
     Ahl Enterprise has had a substantial rise in profit to sales. This is somewhat
     tempered by a reduction in asset turnover. Given a slight rise in common equity,
     there is a substantial rise in return on common equity.


PROBLEM 8-2

a.
                                  2007             2006
       Sales                     100.0%           100.0%
       Cost of goods sold         60.7             60.8
       Gross profit               39.3             39.2
       Selling expense            14.6             20.0
       General expense            10.0              8.3
       Operating income           14.7             10.9
       Income tax                  5.9              4.2
       Net income                 8.8%             6.7%


b.    Starr Canning has had a sharp decrease in selling expense coupled with only a
      modest rise in general expenses giving an overall rise in the net profit margin.


PROBLEM 8-3

      Earnings before interest and tax    $ 245,000
      Interest (750,000 x 6%)                45,000
      Earnings before tax                 $ 200,000
      Tax                                    80,000
      Net income                          $ 120,000
      Preferred dividends                    15,000
      Income available to common          $ 105,000

                     Net Income Before Minority Share of
a. Return on Assets = Earnings and Nonrecurring Items = $120,000 = 4.00%
                             Ending Total Assets         $3,000,000

                               Net Income Before Nonrecurring
                                     Items – Dividends on
b. Return on Total Equity    =
                                Redeemable Preferred Stock    = $120,000 = 6.67%
                                      Ending Total Equity       $1,800,000




                                           224
                                     Net Income Before Nonrecurring Items –
c. Return on Common Equity       =            Preferred Dividends
                                             Ending Common Equity

                                     $120,000 – $15,000
                                                        = 7.00%
                                        $1,500,000

                               Recurring Earnings, Excluding
                           Interest Expense, Tax Expense Equity
d. Times Interest Earned =    Earnings, and Minority Earnings   = $245,000 = 5.44 times
                                 Interest Expense, Including       $45,000    per year
                                     Capitalized Interest



PROBLEM 8-4

                               Vent Molded           Plastics
                                 Plastics            Industry
    Sales                         101.0%              100.3%
    Sales returns                   1.0                 0.3
    Cost of goods sold             72.1                67.1
    Selling expense                 9.4                10.1
    General expense                 7.0                 7.9
    Other income                    0.4                 0.4
    Other expense                   1.5                 1.3
    Income tax                      4.8                 5.5
    Net income                      5.5%                8.5%


    Sales returns are higher than the industry. Cost of sales is much higher, offset
    somewhat by lower operating expenses. Other expense (perhaps interest) is
    somewhat higher. Lower taxes are perhaps caused by lower income. Overall
    profit is less, primarily due to cost of sales.




                                          225
PROBLEM 8-5


     $1,589,150
a.                   =       122.72%
     $1,294,966

      2007 sales were 122.72% of those in 2006.

     $138,204
b.                =          100.80%
     $137,110

      2007 net earnings were 100.80% of those in 2006.

                                          Net Income Before Minority Share of Earnings,
c. 1. Net Profit Margin         =            Equity Income and Nonrecurring Items
                                                           Net Sales

           2007                                  2006
         $149,260                              $149,760       =
                         =   9.39%                                    11.56%
        $1,589,150                            $1,294,966


                                          Net Income Before Minority Share of
     2. Return on Assets        =          Earnings and Nonrecurring Items
                                                  Ending Total Assets

           2007                                    2006
         $149,260                                $149,760         =
                         =   10.38%                                    12.67%
        $1,437,636                              $1,182,110

                                                  Net Sales
     3. Total Asset Turnover          =
                                             Average Total Assets

           2007                                           2006
        $1,589,150                                     $1,294,966
                         =   1.11 times                                 =       1.10 times
        $1,437,636                                     $1,182,110

                                                           Net Profit             Total Asset
     4. DuPont Analysis: Return on Assets              =                    x
                                                            Margin                 Turnover

        2007                 10.42*                    =   9.39%            x         1.11
        2006                 12.72*                    =   11.56%           x         1.10

        *Rounding causes the difference from the 10.38% and 12.67% computed in (2).



                                                 226
5.
                                                    2007                 2006
 Operating income
  Net sales                                       $ 1,589,150       $ 1,294,966
  Less: Cost of product sold                      $ 651,390         $ 466,250
      Research and development expenses               135,314           113,100
      General and selling                             526,680           446,110
 Operating income                                 $ 275,766         $ 269,506

                                    Operating Income
Operating Income Margin       =
                                       Net Sales

                                       2007                   2006
                                     $275,766               $269,506
                                    $1,589,150             $1,294,966

                                    = 17.35%                = 20.81%

                                             Operating Income
6. Return on Operating Assets       =
                                          Ending Operating Assets

                                       2007                   2006
                                     $275,766               $269,506
                                    $1,411,686             $1,159,666

                                    = 19.53%                = 23.24%

                                                 Net Sales
7. Operating Asset Turnover         =
                                          Ending Operating Assets

                                       2007                   2006
                                    $1,589,150             $1,294,966
                                    $1,411,686             $1,159,666

                                    = 1.13 times        = 1.12 times
                                      per year            per year

                                                  Operating             Operating
8. DuPont Analysis: Return on Assets          =    Income       x        Asset
                                                   Margin               Turnover


     2007:                19.61%*             =    17.35%       x         1.13
     2006:                23.31%*             =     20.81       x         1.12

*Rounding causes the difference from the 19.53% and 23.24% computed in (6).


                                        227
                                Net Income Before Minority Share of Earnings and
   9. Return on Investment = Nonrecurring Items + [(Interest Expense) x (1 – Tax Rate)]
                                      Ending (Long-Term Liabilities) + Equity

                                                       2007                   2006
      Net earnings before minority share             $ 149,260             $ 149,760
      Interest expense                                  18,768                11,522
      Earnings before tax                              263,762               271,500
      Provision for income tax                         114,502               121,740
      Tax rate                                            43.4%                 44.8%
      1 – tax rate                                        56.6%                 55.2%
      Interest expense x (1 – tax rate)                 10,623                 6,360
      Net earnings before minority share +
         interest expense x 1(1 – tax rate)]             159,883            156,120
      Long-term debt and equity                        1,019,420            933,232
      Return on investment                                  15.7%              16.7%


                                          Net Income Before Nonrecurring
   10. Return on Common Equity       =      Items – Preferred Dividends
                                               Ending Common Equity

                                            2007             2006
                                          $138,204         $137,110
                                          $810,292         $720,530

                                          = 17.06%         = 19.03%


d. Profits in relation to sales, assets, and equity have all declined. Turnover has
   remained stable. Overall, although absolute profits have increased in 2007,
   compared with 2006, the profitability ratios show a decline




                                           228
   PROBLEM 8-6

                                     Net Income Before Minority Share of Earnings,
a. 1. Net Profit Margin      =          Equity Income and Nonrecurring Items
                                                      Net Sales

         2007                2006                 2005
       $97,051             $51,419              $45,101
      $1,600,000          $1,300,000           $1,200,000

        = 6.07%            = 3.96%                 = 3.76%

                                     Net Income Before Minority Share of
   2. Return on Assets       =        Earnings and Nonrecurring Items
                                            Average Total Assets

         2007                2006                 2005
       $97,051             $51,419              $45,101
      $1,440,600          $1,220,000           $1,180,000

        = 6.74%            = 4.21%                 = 3.82%

                                              Net Sales
   3. Total Asset Turnover       =
                                         Average Total Assets

         2007                2006                 2005
      $1,600,000          $1,300,000           $1,200,000
      $1,440,600          $1,220,000           $1,180,000

       = 1.11 times       = 1.07 times         = 1.02 times
         per year           per year             per year


   4. DuPont Analysis

              Return on Assets       =     Net Profit Margin    x   Total Asset Turnover
      2007:        6.74%             =          6.07%           x        1.11 times
      2006:        4.24%             =          3.96%*          x        1.07 times
      2005:        3.84%             =          3.76%*          x        1.02 times

      *Rounding difference from the 4.21% and 3.82% computed in (2).




                                             229
                                             Operating Income
5. Operating Income Margin          =
                                                Net Sales

                                               2007          2006              2006
   (2) Net sales                            $ 1,600,000    $1,300,000       $ 1,200,000
   Less:
     Material and manufacturing
       costs of products sold                   740,000       624,000           576,000
   Research and development                      90,000        78,000            71,400
   General and selling                          600,000       500,500           465,000
                                            $ 1,430,000    $1,202,500       $ 1,112,400
   (1) Operating income                     $ 170,000      $ 97,500         $ 87,600

   (1) Divided by (2)                          10.63%            7.50%           7.30%


                                                  Operating Income
6. Return on Operating Assets           =
                                               Average Operating Assets

                                           2007              2006            2005
      Operating Income                   $170,000          $97,500         $87,600
   Average Operating Assets             $1,390,200        $1,160,000      $1,090,000

                                        = 12.23%           = 8.41%          = 8.04%


                                                      Net Sales
7. Operating Asset Turnover             =
                                               Average Operating Assets

                                           2007              2006            2005
          Net Sales                     $1,600,000        $1,300,000      $1,200,000
   Average Operating Assets             $1,390,200        $1,160,000      $1,090,000

                                        = 1.15 times      = 1.12 times     = 1.10 times


8. DuPont Analysis with operating ratios

           Return on Assets     =       Operating Income     x       Operating Asset
                                            Margin                     Turnover
   2007:       12.22%*          =           10.63%           x            1.15
   2006:        8.40%*          =            7.50%           x            1.12
   2005:        8.03%           =            7.30%           x            1.10

   *Rounding difference from the 12.23%, 8.41%, and 8.04% computed in (6).


                                             230
                                Net Income Before Minority Share of Earnings and
   9. Return on Investment = Nonrecurring Items + [(Interest Expense) x (1 – Tax Rate)]
                                     Average (Long-Term Liabilities) + Equity

       Estimated tax rate:
                                                       2007           2006             2005
       (1) Provision for income taxes       $           62,049      $ 35,731      $    32,659
       (2) Earnings before income taxes and
           minority equity                  $ 159,100               $ 87,150      $    77,760

       (1) ÷ (2)                                      39.00%         41.00%           42.00%
       1 – tax rate                                   61.00%         59.00%           58.00%

       (3) Interest expense x (1 – tax rate)
       $19,000 x 61.00%                                11,590
       $18,200 x 59.00%                                               10,738
       $17,040 x 58.00%                                                                 9,883

       (4) Earnings before minority equity             97,051         51,419           45,101
       (3) + (4)    (A)                               108,641         62,157           54,984

       (5) Avg. long-term debt                         211,100       121,800          214,000
       (6) Avg. stockholders’ equity                   811,200       790,100          770,000
       (5) + (6)     (B)                             1,022,300       911,900          984,000

       (A) ÷ (B)                                      10.63%          6.82%           5.59%


                                        Net Income Before Nonrecurring Items –
   10. Return on Total Equity     =    Dividends on Redeemable Preferred Stock
                                                 Average Total Equity

                                           2007                2006               2005
       Net income etc.                   $ 86,851           $ 42,919           $ 37,001
       Average total equity              $ 811,200          $ 790,100          $ 770,000

                                           =10.71%               = 5.43%         = 4.81

b. All ratios computed indicate a significant improvement in profitability.




                                               231
PROBLEM 8-7

                                         Net Income Before Minority Share of Earnings,
a. 1. Net Profit Margin      =              Equity Income and Nonrecurring Items
                                                          Net Sales

           2007             2006                    2005
         $171,115         $163,497                $143,990
        $1,002,100        $980,500                $900,000

         = 17.08%         = 16.67%                = 16.00%

                                         Net Income Before Minority Share of
   2. Return on Assets       =            Earnings and Nonrecurring Items
                                                Average Total Assets

           2007             2006                    2005
         $171,115         $163,497                $143,990
         $839,000         $770,000                $765,000

         = 20.40%         = 21.23%                = 18.82%

                                                 Net Sales
   3. Total Asset Turnover           =
                                            Average Total Assets

            2007               2006                      2005
         $1,002,100          $980,500                  $900,000
          $839,000           $770,000                  $765,000

        = 1.19 times      = 1.27 times                = 1.18 times
          per year          per year                    per year



   4. DuPont Analysis

              Return on                    Net Profit Margin                 Total Asset
                                 =                                   x
               Assets                                                         Turnover
      2007:   20.33%*            =              17.08%               x   1.19 times per year
      2006:   21.17%*            =              16.67%               x   1.27 times per year
      2005:   18.88%*            =              16.00%               x   1.18 times per year

      *Rounding difference from the 20.40%, 21.23%, and 18.82% computed in (2).




                                                232
                             Net Income Before Minority Share of Earnings and
5. Return on Investment = Nonrecurring Items + [(Interest Expense) x (1 – Tax Rate)]
                                  Average (Long-Term Liabilities) + Equity

   Estimated tax rate:

                                                    2007           2006         2005
   (1) Provision for income taxes                $ 116,473      $ 113,616    $ 105,560
   (2) Earnings before income taxes              $ 287,588      $ 277,113    $ 249,550
   Tax rate [(1) + (2)]                            40.50%         41.00%       42.30%
   1 – tax rate                                    59.50%         59.00%       57.70%

   (3) Interest expense x (1 – tax rate)
   $14,620 x 59.50%                                 8,699
   $12,100 x 59.00%                                                7,139
   $11,250 x 57.70%                                                                6,491

   (4) Net earnings                               171,115        163,497         143,990
   (3) + (4)     (A)                              179,814        170,636         150,481

   (5) Average long-term debt                     120,000        112,000         101,000
   (6) Average stockholders’ equity               406,000        369,500         342,000
   (5) + (6)     (B)                              34.19%         35.44%          33.97%


                                     Net Income Before Nonrecurring Items –
6. Return on Total Equity     =     Dividends on Redeemable Preferred Stock
                                              Average Total Equity

                                 2007                  2006             2005
   Net earnings                $171,115              $163,497         $143,990
   Average total equity        $406,000              $369,500         $342,000

                               = 42.15%              = 44.25%         = 42.10%


                                          Net Sales
7. Sales to Fixed Assets      =
                                   Average Net Fixed Assets

           2007               2006                  2005
        $1,002,100          $980,500              $900,000
         $302,500           $281,000              $173,000

           = 3.31            = 3.49                = 5.20



                                           233
b. The ratios computed indicate a very profitable firm. Most ratios indicate a slight
   reduction in profitability in 2007.

   Sales to fixed assets has declined materially, but this is the only ratio for which the
   trend appears to be negative.


PROBLEM 8-8

                                  Net Income Before Minority Share of Earnings,
a. 1. Net Profit Margin      =        Equity Income and Nonrecurring Items
                                                   Net Sales

                 2007                     2006                     2005
            $20,070 – $8,028         $16,660 – $6,830         $15,380 – $6,229
               $297,580                 $256,360                 $242,150

                 = 4.05%                  = 3.83%                   = 3.78%


                                  Net Income Before Minority Share of
   2. Return on Assets       =     Earnings and Nonrecurring Items
                                             Total Assets

                 2007                     2006                     2005
            $20,070 – $8,028         $16,660 – $6,830         $15,380 – $6,229
               $145,760                 $137,000                 $136,000

                 = 8.26%                  = 7.18%                   = 6.73%


                                           Net Sales
   3. Total Asset Turnover       =
                                          Total Assets

              2007                  2006                   2005
            $297,580              $256,360               $242,150
            $145,760              $137,000               $136,000

           = 2.04 times          = 1.87 times        = 1.78 times
             per year              per year            per year




                                             234
4. DuPont Analysis

             Return on            Net Profit Margin                 Total Asset
                          =                                  x
              Assets                                                 Turnover
   2007:      8.26%       =               4.05%              x      2.04 times
   2006:      7.16%*      =               3.83%              x      1.87 times
   2005:      6.73%       =               3.78%              x      1.78 times

   *Rounding difference from the 7.18% computed in (2).


                                         Operating Income
5. Operating Income Margin       =
                                            Net Sales

          2007             2006                   2005
         $26,380          $22,860                $20,180
        $297,580         $256,360               $242,150

           = 8.86%       = 8.92%                = 8.33%


                                            End of Year Operating
6. Return on Operating Assets        =             Assets
                                              Operating Income

           2007                      2006                          2005
          $26,380                   $22,860                       $20,180
     $89,800 + $45,850         $84,500 + $40,300             $83,100 + $39,800

           = 19.45%                  = 18.32%                    = 16.42%


                                                  Net Sales
7. Operating Assets Turnover         =      End of Year Operating
                                                   Assets

          2007                      2006                         2005
        $297,580                  $256,360                     $242,150
    $89,800 + $45,850         $84,500 + $40,300            $83,100 + $39,800

       = 2.19 times             = 2.05 times                 = 1.97 times
         per year                 per year                     per year




                                          235
   8. DuPont Analysis

               Return on              Operating Income              Operating Asset
                               =                             x
                Assets                    Margin                       Turnover
      2007:    19.40%*         =           8.86%             x        2.19 times
      2006:    18.29%*         =           8.92%             x        2.05 times
      2005:    16.41%*         =           8.33%             x        1.97 times

      *Rounding difference from the 19.45%, 18.32%, and 16.42% computed in (6).


                                      Gross Profit
   9. Gross Profit Margin      =
                                       Net Sales

          2007               2006             2005
         $91,580            $80,060          $76,180
        $297,580           $256,360         $242,150

        = 30.77%           = 31.23%         = 31.46%



b. Net profit margin and total asset turnover both improved. This resulted in a
   substantial improvement to return on assets.

   Operating income margin declined slightly in 2007 after a substantial improvement in
   2006. Operating asset turnover improved each year. The result of the improvement
   in operating income margin and operating asset turnover was a substantial
   improvement in return on operating assets.

   Gross profit margin declined slightly each year.

   Overall profitability improved substantially over the three-year period.




                                            236
PROBLEM 8-9

                                 Net Income Before Minority Share of
a. 1. Return on Assets       =    Earnings and Nonrecurring Items
                                       End of Year Total Assets

                            2007                  2006                 2005
      (A)               $ 2,100,000           $ 1,950,000          $ 1,700,000
                        $ 2,600,000           $ 2,300,000          $ 2,200,000
                          7,000,000             6,200,000            5,800,000
                            100,000               100,000              100,000
                         10,000,000             9,000,000            8,300,000
      (B)               $19,700,000           $17,600,000          $16,400,000
      (A) ÷ (B)           10.66%                11.08%               10.37%


                                Net Income Before Minority Share of Earnings and
   2. Return on Investment = Nonrecurring Items + [(Interest Expense) x (1 – Tax Rate)]
                                   End of Year (Long-Term Liabilities + Equity)

      Estimated tax rate:

                                                   2007            2006              2005
      (1) Provision for income taxes           $ 1,500,000     $ 1,450,000       $ 1,050,000
      (2) Income before tax                      3,600,000       3,400,000         2,750,000

      Tax rate = (1) ÷ (2)                           41.67%          42.65%           38.18%

      1 – tax rate                                   58.33%          57.35%           61.82%

      (3) Interest expense x (1 – tax rate)
      $800,000 x 58.33%                        $     466,640
      $600,000 x 57.35%                                        $     344,100
      $550,000 x 61.82%                                                          $    340,010

      (4) Net income                           $ 2,100,000     $ 1,950,000       $ 1,700,000

      (3) + (4)      (A)                       $ 2,566,640     $ 2,294,100       $ 2,040,010

      Long-term debt                           $ 7,000,000     $ 6,200,000       $ 5,800,000
      Preferred stock                               100,000         100,000           100,000
      Common equity                              10,000,000       9,000,000         8,300,000
      (B)                                      $ 17,100,000    $ 15,300,000      $ 14,200,000

      (A) ÷ (B)                                     15.01%          14.99%           14.37%



                                              237
                                            Net Income Before Nonrecurring Items –
   3. Return on Total Equity      =        Dividends on Redeemable Preferred Stock
                                                      Ending Total Equity

                2007                          2006                     2005
             $2,100,000                    $1,950,000               $1,700,000
       $100,000 + $10,000,000         $100,000 + $9,000,000    $100,000 + $8,300,000

              = 20.79%                       = 21.43%                 = 20.24%

                                             Net Income Before Nonrecurring
   4. Return on Common Equity          =       Items – Preferred Dividends
                                                  Ending Common Equity

               2007                        2006                        2005
       $2,100,000 – $14,000        $1,950,000 – $14,000        $1,700,000 – $14,000
           $10,000,000                  $9,000,000                  $8,300,000

              = 20.86%                      = 21.51%                 = 20.31%


b. Return on assets improved in 2006 and then declined in 2007. Return on investment
   improved each year. Return on total equity improved and then declined. Return on
   common equity improved and then declined.

   In general, profitability has improved in 2006 over 2005 but was down slightly in
   2007.

c. The use of long-term debt and preferred stock both benefited profitability.

   Return on common equity is slightly more than return on total equity, indicating a
   benefit from preferred stock.

   Return on total equity is substantially higher than return on investment, indicating a
   benefit from long-term debt.




                                              238
PROBLEM 8-10

a.
     Sales                                         $ 120,000
     Gross profit (40%)                               48,000
     Cost of goods sold (60%)                      $ 72,000

     Beginning inventory                           $ 10,000
     + Purchases                                     100,000
     Total available                               $ 110,000
     – Ending inventory                                    ?
     Cost of goods sold                            $ 72,000

     Ending inventory ($110,000 – $72,000)         $ 38,000




b. If gross profit were 50%, the analysis would be as follows:

     Sales                                         $ 120,000
     Gross profit (50%)                               60,000
     Cost of goods sold (50%)                      $ 60,000

     Beginning inventory                           $ 10,000
     + Purchases                                     100,000
     Total available                               $ 110,000
     – Ending inventory                               50,000
     Cost of goods sold                            $ 60,000

     Ending inventory ($110,000 – $60,000)         $ 50,000


If gross profit were higher, the loss would be higher because ending inventory would be
    estimated at $50,000 instead of $38,000.




                                             239
PROBLEM 8-11

                                                             Total
                                      Net     Retained   Stockholders’
                                     Profit   Earnings      Equity
a. A stock dividend is
   declared and paid.                  0         -            0

b. Merchandise is purchased
   on credit.                          0         0            0

c. Marketable securities are
   sold above cost.                    +         +            +

d. Accounts receivable are
   collected.                          0         0            0

e. A cash dividend is
   declared and paid.                  0         -             -

f. Treasury stock is
   purchased and recorded
   at cost.                            0         0             -

g. Treasury stock is sold
   above cost.                         0         0            +

h. Common stock is sold.               0         0            +

i. A fixed asset is sold for
   less than book value.               -         -             -

j. Bonds are converted into
   common stock.                       0         0            +




                               240
PROBLEM 8-12

                                 Net Income Before Minority Share of Earnings
a. 1. Net Profit Margin      =      Equity Income and Nonrecurring Items
                                                 Net Sales

                     $72,700
       2007:                               = 7.42%
                    $980,000

                     $64,900
       2006:                               = 6.76%
                    $960,000

                     $57,800
       2005:                               = 6.15%
                    $940,000

                     $51,200
       2004:                               = 5.69%
                    $900,000

                     $44,900
       2003:                               = 5.10%
                    $880,000



                                          Net Sales
   2. Total Asset Turnover       =
                                     Average Total Assets

                          $980,000
       2007:                                       = 1.14 times per year
                   ($859,000 + $861,000)/2

                          $960,000
       2006:                                       = 1.11 times per year
                   ($861,000 + $870,000)/2

                          $940,000
       2005:                                       = 1.08 times per year
                   ($870,000 + $867,000)/2

                          $900,000
       2004:                                       = 1.04 times per year
                   ($867,000 + $863,000)/2

       2003:       Cannot compute average assets.




                                          241
   Year-End Balance Sheet Figures

               $980,000
   2007:                    = 1.14 times per year
               $859,000

               $960,000
   2006:                    = 1.11 times per year
               $861,000

               $940,000
   2005:                    = 1.08 times per year
               $870,000

               $900,000
   2004:                    = 1.04 times per year
               $867,000

               $880,000
   2003:                    = 1.02 times per year
               $863,000


                          Net Income Before Minority Share of
3. Return on Assets   =    Earnings and Nonrecurring Items
                                 Average Total Assets

   Average Balance Sheet Figures

                       $72,700
   2007:                                    = 8.45%
               ($859,000 + $861,000)/2

                       $64,900
   2006:                                    = 7.50%
               ($861,000 + $870,000)/2

                       $57,800
   2005:                                    = 6.66%
               ($870,000 + $867,000)/2

                       $51,200
   2004:                                    = 5.92%
               ($867,000 + $863,000)/2

   2003:       Cannot compute average assets.




                                    242
   Year-End Balance Sheet Figures

                $72,700
   2007:                     = 8.46%
               $859,000

                $64,900
   2006:                     = 7.54%
               $861,000

                $57,800
   2005:                     = 6.64%
               $870,000

                $51,200
   2004:                     = 5.91%
               $867,000

                $44,900
   2003:                     = 5.20%
               $863,000


4. DuPont Return on Assets   =      Net Profit Margin x Total Asset Turnover

   Average Balance Sheet Figures

   2007:          7.42% x 1.14 times = 8.46%
   2006:          6.76% x 1.11 times = 7.50%
   2005:          6.15% x 1.08 times = 6.64%
   2004:          5.69% x 1.04 times = 5.92%
   2003:          Cannot compute average assets

   Year-End Balance Sheet Figures

   2007:          7.42% x 1.14 times = 8.46%
   2006:          6.76% x 1.11 times = 7.50%
   2005:          6.15% x 1.08 times = 6.64%
   2004:          5.69% x 1.04 times = 5.92%
   2003:          5.10% x 1.02 times = 5.20%




                                     243
                                  Operating Income
5. Operating Income Margin    =
                                     Net Sales

               $355,000 – $240,000
   2007:                                   = 11.73%
                    $980,000

               $344,000 – $239,000
   2006:                                   = 10.94%
                    $960,000

               $333,000 – $238,000
   2005:                                   = 10.11%
                    $940,000

               $320,000 – $239,000
   2004:                                   = 9.00%
                    $900,000

               $314,000 – $235,000
   2003:                                   = 8.98%
                    $880,000



                                         Net Sales
6. Operating Asset Turnover   =
                                  Average Operating Assets

                            $980,000
   2007:                                                 = 1.26 times per year
           ($859,000 – $80,000 + $861,000 – $85,000)/2

                            $960,000
   2006:                                                 = 1.23 times per year
           ($861,000 – $85,000 + $870,000 – $90,000)/2

                            $940,000
   2005:                                                 = 1.21 times per year
           ($870,000 – $90,000 + $867,000 – $95,000)/2

                             $900,000
   2004:                                                = 1.17 times per year
           ($867,000 – $95,000 + $863,000 – $100,000)/2

   2003: Average assets cannot be computed.




                                     244
   Year-End Balance Sheet Figures

                   $980,000
   2007:                                    = 1.26 times per year
               $859,000 – $80,000

                   $960,000
   2006:                                    = 1.24 times per year
               $861,000 – $85,000

                   $940,000
   2005:                                    = 1.21 times per year
               $870,000 – $90,000

                   $900,000
   2004:                                    = 1.17 times per year
               $867,000 – $95,000

                     $880,000
   2003:                                    = 1.15 times per year
                $863,000 – $100,000


                                         Operating Income
7. Return on Operating Assets   =
                                      Average Operating Assets

                       $355,000 – $240,000
   2007:                                                     = 14.79%
           ($859,000 – $80,000 + $861,000 – $85,000)/2

                       $344,000 – $239,000
   2006:                                                     = 13.50%
           ($861,000 – $85,000 + $870,000 – $90,000)/2

                       $333,000 – $238,000
   2005:                                                     = 12.24%
           ($870,000 – $90,000 + $867,000 – $95,000)/2

                       $320,000 – $239,000
   2004:                                                = 10.55%
           ($867,000 – $95,000 + $863,000 – $100,000)/2

   2003: Average assets cannot be computed.




                                      245
   Year-End Balance Sheet Figures

               $355,000 – $240,000
   2007:                                       = 14.76%
               $859,000 – $80,000

               $344,000 – $239,000
   2006:                                   = 13.53%
               $861,000 – $85,000

               $333,000 – $238,000
   2005:                                   = 12.18%
               $870,000 – $90,000

               $320,000 – $239,000
   2004:                                   = 10.49%
               $867,000 – $95,000

               $314,000 – $235,000
   2003:                                   = 10.35%
               $863,000 – $100,000


                                                 Operating Income Margin x
8. DuPont Return on Operating Assets       =
                                                 Operating Asset Turnover

   Average Balance Sheet Figures

   2007:          11.73% x 1.26 = 14.78%
   2006:          10.94% x 1.23 = 13.46%
   2005:          10.11% x 1.21 = 12.23%
   2004:           9.00% x 1.17 = 10.53%
   2003:          Average assets cannot be computed.

   Year-End Balance Sheet Figures

   2007:          11.73% x 1.26 = 14.78%
   2006:          10.94% x 1.24 = 13.57%
   2005:          10.11% x 1.21 = 12.23%
   2004:           9.00% x 1.17 = 10.53%
   2003:           8.98% x 1.15 = 10.33%




                                     246
                                       Net Sales
9. Sales to Fixed Assets   =
                                Average Net Fixed Assets

                   $980,000
    2007:                                   = 1.98
            ($500,000 + $491,000)/2

                   $960,000
    2006:                                   = 1.97
            ($491,000 + $485,000)/2

                   $940,000
    2005:                                   = 1.95
            ($485,000 + $479,000)/2

                   $900,000
    2004:                                   = 1.90
            ($479,000 + $470,000)/2

    2003: Average net fixed assets cannot be computed.




   Year-End Balance Sheet Figures

                $980,000
    2007:                      = 1.96
                $500,000

                $960,000
    2006:                      = 1.96
                $491,000

                $940,000
    2005:                      = 1.94
                $485,000

                $900,000
    2004:                      = 1.88
                $479,000

                $880,000
    2003:                      = 1.87
                $470,000




                                      247
                             Net Income Before Minority Share of Earnings and
10. Return on Investment = Nonrecurring Items + [Interest Expense x (1 – Tax Rate)]
                                  Average (Long-Term Liabilities + Equity)

   Average Balance Sheet Figures

                      $72,700 + $6,500(1 – 0.33)
    2007:                                                      = 11.58%
            ($859,000 – $194,000 + $861,000 – $195,500)/2

                      $64,900 + $6,700(1 – 0.34)
    2006:                                                      = 10.35%
            ($861,000 – $195,500 + $870,000 – $195,500)/2

                      $57,800 + $8,000(1 – 0.34)
    2005:                                                      = 9.37%
            ($870,000 – $195,500 + $867,000 – $195,000)/2

                      $51,200 + $8,100(1 – 0.30)
    2004:                                                      = 8.50%
            ($867,000 – $195,000 + $863,000 – $196,500)/2

    2003: Average long-term liabilities + equity cannot be computed.




   Year-End Balance Sheet Figures


            $72,700 + $6,500(1 – 0.33)
    2007:                                    = 11.59%
              $859,000 – $194,000

            $64,900 + $6,700(1 – 0.34)
    2006:                                    = 10.42%
              $861,000 – $195,500

            $57,800 + $8,000(1 – 0.34)
    2005:                                    = 9.35%
              $870,000 – $195,500

            $51,200 + $8,100(1 – 0.30)
    2004:                                    = 8.46%
              $867,000 – $195,000

            $44,900 + $11,000(1 – 0.34)
    2003:                                    = 7.83%
               $863,000 – $196,500




                                     248
                                   Net Income Before Nonrecurring Items –
11. Return on Total Equity    =   Dividends on Redeemable Preferred Stock
                                            Average Total Equity

   Average Balance Sheet Figures

               $72,700 – $6,400
    2007:                                    = 12.77%
            ($520,000 + $518,000)/2

               $64,900 – $6,400
    2006:                                    = 11.33%
            ($518,000 + $515,000)/2

               $57,800 – $6,400
    2005:                                    = 10.03%
            ($515,000 + $510,000)/2

               $51,200 – $6,400
    2004:                                    = 8.38%
            ($510,000 + $559,000)/2

    2003: Average total equity cannot be computed.




   Year-End Balance Sheet Figures

            $72,700 – $6,400
    2007:                           = 12.75%
               $520,000

            $64,900 – $6,400
    2006:                           = 11.29%
               $518,000

            $57,800 – $6,400
    2005:                           = 9.98%
               $515,000

            $51,200 – $6,400
    2004:                           = 8.78%
               $510,000

             $44,900
    2003:                    = 8.03%
            $559,000




                                       249
                                    Net Income Before Nonrecurring
12. Return on Common Equity   =       Items – Preferred Dividends
                                        Average Common Equity

   Average Balance Sheet Figures

                    $72,700 – $6,400 – $6,300
   2007:                                                     = 13.36%
           ($520,000 – $70,000 + $518,000 – $70,000)/2

                    $64,900 – $6,400 – $6,300
   2006:                                                     = 11.69%
           ($518,000 – $70,000 + $515,000 – $70,000)/2

                   $57,800 – $ 6,400 – $6,300
   2005:                                                     = 10.19%
           ($515,000 – $70,000 + $510,000 – $70,000)/2

                    $51,200 – $6,400 – $6,300
   2004:                                                     = 8.76%
           ($510,000 – $70,000 + $559,000 – $120,000)/2

   2003: Average common equity cannot be computed.



   Year-End Balance Sheet Figures

           $72,700 – $6,400 – $6,300
   2007:                                     = 13.33%
              $520,000 – $70,000

           $64,900 – $6,400 – $6,300
   2006:                                     = 11.65%
              $518,000 – $70,000

           $57,800 – $ 6,400 – $6,300
   2005:                                     = 10.13%
              $515,000 – $70,000

           $51,200 – $6,400 – $6,300
   2004:                                     = 8.75%
              $510,000 – $70,000

            $44,900 – $10,800
   2003:                               = 7.77%
           $559,000 – $120,000




                                     250
                                       Gross Profit
     13. Gross Profit Margin     =
                                        Net Sales


                 $355,000
         2007:                  = 36.22%
                 $980,000

                 $344,000
         2006:                  = 35.83%
                 $960,000

                 $333,000
         2005:                  = 35.43%
                 $940,000

                 $320,000
         2004:                  = 35.56%
                 $900,000

                 $314,000
         2005:                  = 35.68%
                 $880,000



b.      In general, the profitability appears to be very good and the trend is positive.

        There was not a significant difference in results between using average balance
        sheet figures and year-end figures. The year-end figure allowed for an additional
        year was not a very profitable year in relation to subsequent years.




                                             251
PROBLEM 8 - 13

a.   4   Interest expense represents a recurring item.

b.   5   Ideally, return on common equity will indicate the highest return. This is the
         way it should be since the common equity holders take the most risk.

c.   3   A selling price increase would increase the gross profit.

d.   2   It would not be feasible to estimate administrative expenses by using gross
         profit analysis.

e.   2   Total asset turnover measures the ability of the firm to generate sales through
         the use of assets.

f.   4   Equity earnings can represent a problem in analyzing profitability because
         equity earnings are not from operations.

g.   1   Intangibles are not considered to be an operating asset.

h.   4   Earnings based on percent of holdings by outside owners of consolidated
         subsidiaries are termed minority earnings.

i.   1   Net profit margin x total asset turnover measures DuPont return on assets.

j.   4   If net profit margin declines and the total asset turnover declines, then the
         return on assets cannot rise.

k.   3   A reason that equity earnings create a problem in analyzing profitability is
         because equity earnings are usually less than the related cash flow.

l.   3   Usually the return on common equity will have the highest percent of the ratios
         listed.

m.   4   Usually the return on total assets will have the lowest percent of the ratios
         listed.

n.   4   Gain from selling land will be reported on the income statement.

o.   5   None of the above describes minority share of earnings.

p.   1   Purchase of land at year-end could cause return on assets to decline when the
         net profit margin is increasing. The year-end purchase of land would not have
         contributed to profits.




                                         252
CASES

CASE 8-1 JEFF’S SELF-SERVICE STATION

Profitability Planning

(This case is effective in illustrating the entity concept, return on investment, cash flow,
and the subjective nature of decision making.)

a. Indicated return on investment:

   Average profit for 2007 and 2006:                     2007:        $ 20,630
                                                         2006:          17,925
                                                                      $ 38,555

                                                         Average      $ 19,277


   Depreciation as computed on the prior cost base                    $ 1,000
   Depreciation as computed on the purchase cost                        (2,000)
   Adjusted profit                                                     18,277
   Tax, 50% rate                                                         9,139
   Net income                                                         $ 9,138


                                      $9,138
   Return on Investment          =             =     13.05%
                                     $70,000


b. Indicated return on investment if help were hired to operate the station:

   Adjusted profit in part (a)                                         $ 18,277
   Less cost of hired help                                               10,000
   New adjusted profit                                                 $ 8,277
   Tax, 50% rate                                                          4,139
   Net income                                                          $ 4,138


                                      $4,138
   Return on Investment          =             =     5.91%
                                     $70,000

c. In (a), there is no salary expense. In (b), the salary expense for hired help of
   $10,000 is deducted. This lowers the taxable income and taxes, giving a net effect
   of $5,000. The rate of return in (a) must be higher to compensate for the opportunity
   cost of the salary to the owner.



                                               253
   The difference between the rates of return is misleading in terms of judging the
   investment. The records only reflect the actual cost, while disregarding opportunity
   cost and personnel time not compensated. All costs need to be considered when
   judging the investment.

d. Indicated cash flow:

   Receipts:                                                          2008
    Revenue                                                        $ 185,060

   Outlays:
    Cost of goods sold                                               160,180
    Added inventory                                                   10,000
    Real estate and property taxes                                     1,100
    Repairs and maintenance                                            1,470
    Other expenses                                                       680
        Total outlays                                              $ 173,430

   Net cash flow, excluding tax expense                                11,630

   Less taxes (a)                                                       9,815
   Net cash flow                                                   $    1,815

   (a) Cash flow prior to taxes                                    $ 11,630
     Add inventory                                                   10,000
     Deduct depreciation                                             (2,000)
     Profit                                                        $ 19,630
     Taxes                                                         $ 9,815


e. Many other considerations can be discussed. Some of these include:

   1. Future tax rate.

   2. Psychological value of owning the business.

   3. Can Mr. Dearden adequately serve as manager?

   4. Will he be able to maintain or increase the business that was enjoyed by Mr.
      Szabo?

   5. Will there be appreciation in the value of the property?

   6. Other investment alternatives.




                                           254
f. This is a subjective question. Either a yes or no answer is acceptable. This
   question should be discussed in relation to the above questions.


CASE 8-2 WORKING ON THE RAILROAD

(This case represents an opportunity to review segment reporting).

1.
                                     Geographic Data
                                 Horizontal Common-Size
                            For the Years ended December 31,

                                                  2006        2005            2004
           Operating revenues:
           United States                          153.9       132.2         100.0 %
           Canada                                 126.2       115.8         100.0
           Australia                               N/A         -----         -----
           Mexico                                  84.7       105.2         100.0
           Total operating revenues               157.6       126.9         100.0


     The best area by a substantial margin was the United States, followed by Canada.
     Total operating revenues was up the most. It was aided by Australia which was not
     part of the 2005 or 2004 operating revenues. Operating revenues in Mexico were
     down substantially.

2.
                                     Geographic Data
                                 Horizontal Common-Size
                            For the Years ended December 31,

                                                      2006             2005
                 Long-lived assets located in:
                 United States                        82.0             100.0
                 Canada                               146.1            100.0
                 Australia                             N/A              -----
                 Mexico                               14.9             100.0
                 Total long-lived assets              88.1             100.0

     Long-lived assets were increased very materially in Canada. They decreased
     materially in the United States. The decrease was so substantial in Mexico that they
     may be leaving Mexico.

3. The vertical common-size analysis for operating revenues is misleading because
   Australia entered the picture in 2006, contributing 9.7% of operating revenues.


                                            255
     The United States is the major contributor, with over 70.0% of operating revenues.
     The contribution of Mexico is declining.

4. The United States has over 80.0% of long-lived assets. There has been a material
   increase in Canada and a material decrease in Mexico.

5. The United States represents the major contributor to operating revenues. Australia
   entered in 2006 making a substantial contribution to operating revenues. Mexico’s
   contribution has declined substantially.

6. The United States has the majority of the long-lived assets. There was a material
   increase in Canada and a material decrease in Mexico.



CASE 8-3 THE STORY OF STARBUCKS – IN SEGMENTS

(This case represents an opportunity to review Starbucks in segments.)

a.
                                         Starbucks
                                  Vertical Common-Size
                                Fiscal 2006, Net Revenues

                                      United
                                      States      International   Global CPG       Total
     Fiscal 2006
     Net revenues
        Company-operated retail        88.9           83.5                         84.5
        Specialty:
         Licensing                      6.0          14.3            100.0         11.1
         Foodservice and other          5.1           2.2             -----         4.4
            Total Specialty            11.1          16.5            100.0         15.5
     Total net revenues                100.0         100.0           100.0         100.0




                                            256
b.
                                      Starbucks
                               Horizontal Common-Size
                         Net Revenues from External Customers


       Fiscal Year Ended          Oct. 1, 2006      Oct. 2, 2005     Oct. 3, 2004
       Net revenues from
           external customers:
         United States               143.9            118.8            100.0
         Foreign countries           165.1            128.9            100.0
       Total                         147.1            120.3            100.0


c.
                                        Starbucks
                                 Horizontal Common-Size
                                   Long-Lived Assets

          Fiscal Year Ended          Oct. 1, 2006     Oct. 2, 2005     Oct. 3, 2004
          Long-lived assets:
            United States              140.6             110.1            100.0
            Foreign countries          151.1             130.0            100.0
          Total                        142.2             113.0            100.0


d. Comment on (a)

     Most of the net revenues comes from the United States.

     Licensing revenues represents a much bigger proportion in international than the
     United States. Licensing represents 100.0% under Global CPG.

     Comment on (b)

     Net revenues were up materially more in foreign countries vs. the United States. Net
     revenues increased materially in both the United States and foreign countries.

c. Comment on (c)

     Long-lived assets increased much faster in foreign countries than in the United
     States.

     Long-lived assets increased materially in both the United States and foreign
     countries.



                                             257
CASE 8-4 SCOREBOARDS, ELECTRONIC DISPLAYS, ETC.

1.
                                       2005               2004

     Net Profit Margin                $15,660            $17,745
                                     $230,346           $209,907
                                      6.80%               8.45%


2.
     Total Asset Turnover            $230,346            $209,907
                                     $151,462            $126,236
                                    1.52 times           1.66 times


3.
     Return on Assets                 $15,660            $17,745
                                     $151,462           $126,236
                                      10.34%             14.06%


4.
     Operating income margin          $19,436            $27,530
                                     $230,346           $209,907
                                      8.44%              13.12%


5.
     Return on Operating Assets       $19,436             $27,530
                                  $151,462 - $2,621   $126,236 - $1,411
                                       - $1,101            - $920
                                      13.16%              22.22%


6.
     Sales to Fixed Assets           $230,346           $209,907
                                      $31,053            $25,096
                                    7.42 times          8.36 times




                                     258
 7.
                                               2005                        2004

       Return on Investment                 $15,660 +                   $17,745 +
                                      [$211 x (1 – 26.98%)]        [$478 x (1 – 38.07%)]
                                        $5,556 + $103,910            $4,675 + $86,264

                                            $15,814.07                  $18,041.03
                                             $109,466                    $90,939
                                              14.45%                      19.84%
 8.
       Return on Total Equity                $15,660                      $17,727
                                            $103,910                      $86,264
                                             15.07%                       20.55%

 9.
       Return on Common Equity               $15,660                      $17,727
                                            $103,910                      $86,264
                                             15.07%                       20.55%

 10.
       Gross Profit Margin                   $73,209                       $72,471
                                            $230,346                      $209,907
                                             31.78%                        34.53%


b. These ratios considered together indicate a material decline in profitability.
   However, even after the material decline in profitability, the 2005 ratios indicate very
   good profitability.


CASE 8-5 YAHOO SERVICES

a. 1.
                                              2003                          2004

       Net Profit Margin               $343,172 - $147,024         $1,185,024 - $437,966
                                           $1,625,097                   $3,574,517
                                              12.07%                       20.90%

   2.
     Total Asset Turnover                   $1,625,097                    $3,574,517
                                            $5,931,654                    $9,178,201
                                            0.27 times                     0.39 times

                                            259
3.
  Return on Assets             $343,172 - $147,024     $1,185,024 - $437,966
                                    + $47,652                + $94,991
                                   $5,931,654               $9,178,201
                                     4.11%                    9.17%

4.
  Operating Income Margin           $295,666                  $688,581
                                   $1,625,097                $3,574,517
                                     18.19%                   19.26%

5.
  Return on Operating Assets         $295,666                 $688,581
                               $1,721,709 + $449,512    $4,090,495 + 531,696
                                         13.62%               14.90%

6.
  Sales to Fixed Assets             $1,625,097               $3,574,517
                                     $449,512                 $531,696
                                    3.62 Times               6.72 Times

7.
  Return on Investment          $343,172 – $147,024    $1,185,024 – $437,966
                               $750,000 + $72,890 +    $65,875 + $750,000 +
                                $37,478 + 4,363,490     $35,907 + 44,266 +
                                                            $7,101,446
                                      3.75%                    9.34%

8.
  Return on Total Equity             $237,879                 $839,553
                                    $4,363,490               $7,101,446
                                         5.45%                11.82%

9.
  Gross Profit Margin               $1,266,994               $2,275,958
                                    $1,625,097               $3,574,517
                                         77.96%               63.67%




                                   260
  b. Many of the ratios showed a material increase in profitability (net profit margin, total
     asset turnover, return on assets, sales to fixed assets, return on investment, and
     return on total equity).

      Operating income margin improved slightly.

      Gross profit margin declined materially.

      The increase in revenues has been able to make up for the decline in gross profit
      margin.


  c. 1.
                                      Yahoo Services
                           Consolidated Statements of Operations
                                 Horizontal Common-Size

                                                           Years Ended December 31,
                                                      2002          2003          2004
Revenues                                              100.0 %        170.5 %        375.1 %
Cost of revenues                                      100.0          219.9          797.2
Gross profit                                          100.0          160.3          288.0
Operating expenses:
  Sales and marketing                                 100.0              123.4           181.0
  Product development                                 100.0              146.2           260.1
  General and administrative                          100.0              156.0           260.8
  Stock compensation expense                          100.0              262.2           384.3
  Amortization of intangibles                         100.0              256.7           687.7
  Total operating expenses                            100.0              138.4           226.1
Income from operations                                100.0              335.3           780.8
Other income, net                                     100.0               68.6           716.5
Income before income taxes, earnings in equity
  interest, minority interests, and cumulative
  effect of accounting change                         100.0              217.9           752.5
Provision for income taxes                            100.0              206.2           614.3
Earnings in equity interests                          100.0              213.7           425.9
Minority interests in operations of consolidated
   subsidiaries                                       100.0              381.8           160.9
Net income before cumulative effect of
  accounting change                                   100.0              222.5           785.1
Cumulative effect of accounting change                100.0               N/A             N/A
Net income                                            100.0              555.6         1,960.9




                                              261
2. Material increase in all items

   The biggest increase was in net income, but this increase was distorted by the
   cumulative effect of accounting change in the base year



CASE 8-6 EAT AT MY REASTAURANT – PROFITABILTY

(This case represents an opportunity to view the profitability of three restaurants.)

a. Net Profit Margin

   Yum Brands has the highest net profit margin, followed by Panera Bread, and then
   Starbucks. (Yum Brands and Panera Bread had the same net profit margin in 2005).

   The trend was positive for Yum Brands and negative for Panera Bread and
   Starbucks.

b. Return on Assets

   Starbucks had the best return on assets. Yum Brands had a better return in 2006
   than Panera Bread. Panera Bread had a better return in 2005 than did Yum Brands.

   The trend was favorable for Yum Brands and Starbucks. The trend was negative for
   Panera Bread.

c. Return on Total Equity

   Yum Brands had a materially better return on total equity than did Panera Bread or
   Starbucks. Starbucks was in second place followed by Panera Bread.

   The trend was favorable for Yum Brands and Starbucks. The trend was negative for
   Panera Bread.

d. Yum Brands is the more profitable firm in an investor’s view because of the
   outstanding return on total equity. Starbucks would be considered in second place
   considering its return on total equity and return on assets.




                                            262
THOMSON ONE

1. This Thomson One exercise provides for a comment on the trend on selected
   profitability ratios for Merck & Company.

2. This Thomson One exercise provides for comments on the trend in selected
   profitability ratios for Anheuser-Busch and Molson Coors Brewing Company. It also
   provides for a comparison of the Anheuser-Busch profitability ratios with Molson
   Coors Brewing Company profitability ratios.

3. This Thomson One exercise provides for comments on the trend in selected
   profitability ratios for Apple Computer, Dell Computer, and Hewlett-Packard. It also
   provides for a comparison of the profitability ratios of Apple Computer, Dell
   Computer, and Hewlett-Packard.




                                           263

				
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