CB3041 Financial Statement Analysis

Group Assignment (10%)

Submit Through Canvas Before: 11:59 pm, Thursday, 17 Apr. 2025
Answer Release Through Canvas: Friday, 18 Apr. 2025
Late Submission Is Not Allowed

PART 1. SHORT ANSWER QUESTIONS

For each short answer question, respond in five sentences or fewer.

Question 1 [5 pts]
Briefly discuss the role of financial statement analysis in promoting capital market
efficiency.

Question 2 [5 pts]
Evaluate the historical cost model and revaluation model based on two characteristics
of accounting information quality: faithful representation and relevance.

Question 3 [5 pts]
Provide one example of non-recurring item that affects income. Why do we need to
exclude its effect when doing financial statement analysis?

Question 4 [5 pts]
After separating the operating and financing components, what ROE disaggregation
formula will we obtain? Based on that, under what circumstances will ROE exceed
operating ROA?

Question 5 [5 pts]
What are the two types of earnings management? Provide an example for each of them.

Question 6 [5 pts]
How are earnings quality and balance sheet quality related? Is there a case where
accounting choice compromises earnings quality but improves balance sheet quality?
 PART 2. SHORT PROBLEMS

Question 7 [7 pts]
A firm purchased a machine using $400,000 in cash two years ago. At the end of last
year, the machine had a fair value of 320,000. At the end of this year, its fair value
increased to 410,000. Assume the firm uses the revaluation model for the machine and
ignores its depreciation for this question.
Required: using the analytical framework below, indicate how the purchase and
revaluation of the machine affected the financial statement during the two years. Put 0
if there is no effect on specific items.

Cash + Non Cash Assets = Liabilities + Contributed Capital + AOCI + Retained Earnings

Question 8 [8 pts]
Cap Corp and Exp Corp both buy one piece of equipment for $30,000 at the beginning
of the year. The two firms are identical in all aspects except for the treatment of this
newly bought equipment. Cap Corp capitalizes the equipment and assumes that it has a
life of 3 years and zero salvage value. Cap Corp uses the straight-line depreciation
method. However, Exp Corp expenses the purchase of equipment immediately. At the
year-end, Exp Corp reports shareholder equity being $2,000,000 and net income of
$80,000. Assume the tax rate to be 20% and no dividend paid.
Required: what is the return on equity (ROE) for two firms? For this question, please
only use the end-of-year shareholder equity as the denominator for ROE calculation.
PART 3. FINANCIAL STATEMENT PROBLEMS

Question 9 [15 pts]

The table next page presents common-size condensed balance sheets and income
statements for 5 firms in different industries. These common-size balance sheets and
income statements express various items as a percentage of operating revenues. A dash
for a particular financial statement item does not necessarily mean the amount is zero.
It merely indicates that the amount is not sufficiently large enough for the firm to
disclose it. A list of the 5 companies and a brief description of their activities follow.
Citigroup: Offers a wide range of financial services in the commercial banking,
insurance, and securities business. Operating expenses represent the compensation of
employees.
eBay: Operates an online trading platform for buyers to purchase and sellers to sell a
variety of goods. The firm has grown in part by acquiring other companies to enhance
or support its online trading platform.
Goldman Sachs: Offers brokerage and investment banking services. Operating
expenses represent the compensation of employees.
Verizon: Maintains a telecommunications network and offers telecommunications
services. Operating expenses represent the compensation of employees. Verizon has
made minority investments in other cellular and wireless providers.
Johnson & Johnson: Develops, manufactures, and sells pharmaceutical products,
medical equipment, and branded over-the-counter consumer personal care products.
Required:
Use the ratios to match the companies in table with the firms listed above and explain
your reasoning.
 Firm (1) (2) (3) (4) (5)
Balance Sheet % % % % %
Cash and Marketable Securities 2,256.1 20.1 10.6 2,198.0 39.3
Receivables 352.8 15.2 12.0 1,384.8 5.1
Inventories - 7.9 2.1 - -
Property, Plant, and Equipment, at
- 43.0 221.5 - 32.9
cost
Accumulated Depreciation - (20.4) (132.6) - (18.9)
Intangibles - 43.4 75.2 101.9 90.9
Other Assets 57.3 24.0 19.0 208.5 33.3
Total Assets 2,666.2 133.2 207.9 3,893.3 182.6

Liabilities and Equity % % % % %

Current Liabilities 2,080.8 32.7 26.6 2,878.4 43.4
Long-Term Debt 390.9 12.7 48.2 596.1 -
Other Long-term Liabilities 92.6 21.1 90.2 171.3 9.4
Shareholders' Equity 101.9 66.7 42.8 247.5 129.8
Total Liabilities and Equity 2,666.2 133.2 207.9 3,893.3 182.6

Income Statement % % % % %
Sales 100.0 100.0 100.0 100.0 100.0
Cost of sales (54.6) (29.0) (40.1) (73.4) (26.7)
SG&A expenses (1.4) (29.3) (27.6) (5.1) (33.7)
R&D expenses (1.6) (12.2) - (7.7) (8.5)
Depreciation and amortization (2.0) (4.4) (15.0) (5.0) (2.8)
Other expenses or income (8.0) 1.6 (5.5) (28.8) -
Interest expense or income 9.5 (0.1) (1.9) 78.4 1.3
Tax expense (14.3) (6.2) (3.4) (16.0) (4.7)
Net Income 27.6 20.3 6.6 42.3 25.5
Question 10 [20 marks]
The following information is from the balance sheet and income statement.
Required:
(1) Prepare the worksheet for the statement of cash flows for Year 2. [16 marks]
(2) Identify the main reason for the difference between net income and cash flow from
operations, and comment on the relations among cash flows from operating, investing,
and financing activities for Year 2. [4 marks]

Balance Sheet Year 2 Year 1

Assets
Cash 21,000 19,500
Accounts receivable 48,200 47,600
Inventory 30,100 29,800
Prepayment 9,800 10,100
Equipment (net) 1,645,000 1,650,000
Goodwill (net) 48,000 57,000
Total Assets 1,802,100 1,814,000

Liabilities and Equity

Accounts payable 59,000 58,500
Notes payable 99,800 105,400
Long-term debt 905,000 965,600
Common stock 9,300 9,500
Additional paid-in capital 142,500 147,000
Retained earnings 586,500 528,000
Total Liabilities and Equity 1,802,100 1,814,000

Income Statement Year 2

Sales 484,000
Cost of goods sold (170,000)
Gross Profit 314,000
Selling, general, and administration
(96,500)
expenses
Depreciation expense (88,000)
Operating Income 129,500
Gain (loss) on sale of equipment (3,500)
Goodwill impairment (9,000)
Interest expense (43,000)
Tax expense (12,800)
Net income 61,200
Question 11 [20 pts]
The table on the next page presents information from the balance sheet and income
statement. Based on that, answer the questions below:
(1) Calculate the selected financial ratios for the firm in Year 2. Assume the tax rate to
be 20%.

Year 2 Year 1
ROA 10.97%
Profit Margin for ROA 19.90%
Total Asset Turnover 0.55
Current Ratio 1.34
Quick Ratio 0.67
Cash Ratio 0.28
Liabilities to Equity Ratio 0.81
Long-term Debt to Equity Ratio 0.33
Interest Coverage Ratio 6.52

(2) Based on the financial ratios calculated above, how does the firm’s profitability
change in Year 2 and what is the driver?
(3) Based on the financial ratios calculated above, how do the firm’s short-term
liquidity risk and long-term solvency risk change in Year 2?
Balance Sheet Year 2 Year 1
Assets
Cash and cash equivalents 3,400 5,600
Short-term investments 1,800 3,200
Accounts receivable 5,600 4,700
Inventory 7,000 5,500
Other current assets 8,800 8,300
Total Current Assets 26,600 27,300
Property, plant, and equipment 41,100 36,200
Long-term investments 4,200 6,200
Goodwill and intangible assets 37,100 33,600
Other noncurrent assets 11,300 8,800
Total Assets 120,300 112,100

Liabilities and Equity

Short-term debt 1,700 4,600
Accounts payable 2,000 2,500
Accrued and other current liabilities 11,700 13,200
Total Current Liabilities 15,400 20,300
Long-term debt 26,200 20,600
Other noncurrent liabilities 9,700 9,200
Total Liabilities 51,300 50,100
Total Equity 69,000 62,000
Total Liabilities and Equity 120,300 112,100

Income Statement
Sales 62,700
Cost of goods sold (23,700)
Gross Profit 39,000
Selling, general and administrative expenses (7,400)
Research and development expenses (13,500)
Operating Income 18,100
Interest expense (2,600)
Tax expense (3,300)
Net Income 12,200