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NATIONAL INSTITUTE OF BUSINESS 45 FINANCIAL MANAGEMENT

EXERCISE
1. Frantic Fast Foods had earnings after taxes of $390,000 in the year 2024 with 300,000 shares
outstanding. On January 1, 2025, the firm issued 25,000 new shares. Because of the proceeds
from these new shares and other operating improvements, earnings after taxes increased by 20
percent.
a. Compute earnings per share for the year 2024.
b. Compute earnings per share for the year 2025.

Answer
a. Year 2024
...........................................................................................................................................................
...........................................................................................................................................................
...........................................................................................................................................................
...........................................................................................................................................................
b. Year 2025
...........................................................................................................................................................
...........................................................................................................................................................
...........................................................................................................................................................
...........................................................................................................................................................

2. Rod Fishing Supplies had sales of $2,000,000 and cost of goods sold of $1,250,000. Selling
and administrative expenses represented 8 percent of sales. Depreciation was 5 percent of the
total assets of $4,000,000. What was the firm’s operating profit?

Answer
Rod Fishing Supplies
Sales.......................................................................................
Cost of goods sold.................................................................
Gross Profit......................................................................
Selling and administrative expense*.....................................
Depreciation expense**.........................................................
Operating profit...............................................................

* ...............................................................................
** .......................................................................

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3. Prepare in good form an income statement for ATM Cards, Inc. Take your calculations all the
way to computing earnings per share.
Sales....................................................................................... $800,000
Shares outstanding................................................................. 100,000
Cost of goods sold.................................................................. 300,000
Interest expense...................................................................... 20,000
Selling and administrative expense........................................ 40,000
Depreciation expense............................................................. 30,000
Preferred stock dividends....................................................... 80,000
Taxes...................................................................................... 110,000

Answer
ATM Cards, Inc.
Income Statement
Sales.......................................................................................
Cost of goods sold.................................................................
Gross profit......................................................................
Selling and administrative expense.......................................
Depreciation expense.............................................................
Operating profit...............................................................
Interest expense.....................................................................
Earnings before taxes.......................................................
Taxes......................................................................................
Earnings after taxes.........................................................
Preferred stock dividends......................................................
Earnings available to common stockholders.........................
Shares outstanding.................................................................
Earnings per share.................................................................

4. Stein Books, Inc. sold 1,400 finance textbooks for $195 each to High Tuition University in
2024. These books cost $150 to produce. Stein Books spent $12,000 (selling expense) to
convince the university to buy its books.
Depreciation expense for the year was $15,000. In addition, Stein Books borrowed
$100,000 on January 1, 2025, on which the company paid 10 percent interest. Both the interest
and principal of the loan were paid on December 31, 2025. The publishing firm’s tax rate is 30
percent.
Did Stein Books make a profit in 2025? Please verify with an income statement presented
in good form.

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Answer
Stein Books, Inc.
Income Statement
For the Year Ending December 31, 2025

Sales (1,400 books at $195 each)...............................................................

Cost of goods sold (1,400 books at $150 each) ........................................
Gross Profit..........................................................................................
Selling expense...........................................................................................
Depreciation expense.................................................................................
Operating profit……............................................................................
Interest expense ($100,000 × 10%)............................................................
Earnings before taxes...........................................................................
Taxes @ 30%.......................................................................................
Earnings after taxes..............................................................................

5. Lemon Auto Wholesalers had sales of $700,000 in 2025 and cost of goods sold represented 70
percent of sales. Selling and administrative expenses were 12 percent of sales. Depreciation
expense was $10,000 and interest expense for the year was $8,000. The firm’s tax rate is 30
percent.
a. Compute earnings after taxes.
b. Assume the firm hires Ms. Carr, an efficiency expert, as a consultant. She suggests that
by increasing selling and administrative expenses to 14 percent of sales, sales can be
increased to $750,000. The extra sales effort will also reduce cost of goods sold to 66
percent of sales (There will be a larger markup in prices as a result of more aggressive
selling). Depreciation expense will remain at $10,000. However, more automobiles will
have to be carried in inventory to satisfy customers, and interest expense will go up to
$15,000. The firm’s tax rate will remain at 30 percent. Compute revised earnings after
taxes based on Ms. Carr’s suggestions for Lemon Auto Wholesalers. Will her ideas
increase or decrease profitability?

Answer
Lemon Auto Wholesalers
Income Statement
a.
Sales.............................................................................................
Cost of goods sold (70% of sales)................................................
Gross Profit............................................................................
Selling and administrative expense
(12% of sales)........................................................................
Depreciation.................................................................................
Operating profit......................................................................
Interest expense............................................................................
Earnings before taxes.............................................................
Taxes @ 30%...............................................................................
Earnings after taxes

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b.
Sales.............................................................................................
Cost of goods sold (66% of sales) ...............................................
Gross profit............................................................................
Selling and administrative expense
(14% of sales) .......................................................................
Depreciation.................................................................................
Operating profit......................................................................
Interest expense............................................................................
Earnings before taxes.............................................................
Taxes @ 30%...............................................................................
Earnings after taxes................................................................
Ms. Carr’s ideas will increase profitability.

6. Arrange the following items in proper balance sheet presentation:

Accumulated depreciation..................................................... $300,000
Retained earnings................................................................... 96,000
Cash........................................................................................ 10,000
Bonds payable........................................................................ 136,000
Accounts receivable............................................................... 48,000
Plant and equipment—original cost....................................... 680,000
Accounts payable................................................................... 35,000
Allowance for bad debts........................................................ 6,000
Common stock, $1 par, 100,000 shares outstanding............. 100,000
Inventory................................................................................ 66,000
Preferred stock, $50 par, 1,000 shares outstanding............... 50,000
Marketable securities............................................................. 20,000
Investments............................................................................ 20,000
Notes payable......................................................................... 33,000
Capital paid in excess of par (common stock) ...................... 88,000

Answer
Assets
Current Assets:
Cash..............................................................
Marketable securities.....................................
Accounts receivable.......................................
Less: Allowance for bad debts................
Inventory........................................................
Total Current Assets................................
Other Assets:
Investments....................................................
Fixed Assets:
Plant and equipment.......................................
Less: Accumulated depreciation. ...........
Net plant and equipment................................
Total Assets..............................................

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Liabilities and Stockholders’ Equity

Current Liabilities:
Accounts payable..................................................................................
Notes payable........................................................................................
Total current liabilities......................................................................
Long-term Liabilities:
Bonds payable.......................................................................................
Total Liabilities.................................................................................
Stockholders’ Equity:
Preferred stock, $50 par, 1,000 shares outstanding..............................
Common stock, $1 par, 100,000 shares outstanding............................
Capital paid in excess of par (common stock)......................................
Retained earnings..................................................................................
Total Stockholders’ Equity...............................................................
Total Liabilities and Stockholders’ Equity.........................

7. Okra Snack Delights, Inc., has an operating profit of $210,000. Interest expense for the year
was $30,000; preferred dividends paid were $24,700; and common dividends paid were $36,000.
The tax was $59,300. The firm has 16,000 shares of common stock outstanding.
a. Calculate the earnings per share and the common dividends per share.
b. What was the increase in retained earnings for the year?

Answer
Okra Snack Delights, Inc.
a. Operating profit (EBIT).....................................................................
Interest expense............................................................................
Earnings before taxes (EBT)..............................................................
Taxes............................................................................................
Earnings after taxes (EAT)................................................................
Preferred dividends......................................................................
Available to common stockholders....................................................
Common dividends......................................................................
Increase in retained earnings..............................................................
...........................................................................................................................................................
...........................................................................................................................................................
...........................................................................................................................................................
...........................................................................................................................................................
...........................................................................................................................................................
Dividends per Share =............................................................................................
= ..........................................................................................

b. Increase in retained earnings =..............................................................................

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8. Botox Facial Care had earnings after taxes of $280,000 in 2024 with 200,000 shares of stock
outstanding. The stock price was $30.80. In 2025, earnings after taxes increased to $320,000
with the same 200,000 shares outstanding. The stock price was $40.00
a. Compute earnings per share and the P/E ratio for 2024.
The P/E ratio equals the stock price divided by earnings per share.
b. Compute earnings per share and the P/E ratio for 2025.
c. Give a general explanation of why the P/E ratio changed
Answer
a.
................................................................................................................................................
.........................................................................................................................................
.........................................................................................................................................
.........................................................................................................................................
..................................................................................................................................

b. ....................................................................................................................................
.........................................................................................................................................
.........................................................................................................................................
.........................................................................................................................................
.........................................................................................................................................
.....
c. ...........................................................................................................................

9. The Jupiter Corporation has a gross profit of $700,000 and $240,000 in depreciation expense.
The Saturn Corporation also has $700,000 in gross profit, with $40,000 in depreciation expense.
Selling and administrative expense is $160,000 for each company.
Given that the tax rate is 40 percent, compute the cash flow for both companies. Explain
the difference in cash flow between the two firms.
Answer
Jupiter Corporation – Saturn Corporation
Jupiter Saturn
Gross profit…………………………………………
Selling and adm. Expense………………………….
Depreciation………………………………………..
Operating profit…………………………………….
Taxes (40%)………………………………………..
Earnings after taxes…………………………………
Plus depreciation expense………………………….
Flow Cash..................................................................
Jupiter had $200,000 more in depreciation which provided $80,000 (0.40  $200,000)
more in cash flow.

10. Coastal Pipeline, Inc., anticipated cash flow from operating activities of $8 million in 2025.
It will need to spend $1.5 million on capital investments in order to remain competitive within
the industry. Common stock dividends are projected at $0.6 million and preferred stock
dividends at $0.25 million.
a. What is the firm’s projected free cash flow for the year 2025?
b. What does the concept of free cash flow represent?
Answer

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Coastal Pipeline, Inc.

a. Cash flow from operations activities...............................
- Capital Expenditures.....................................................
- Common stock dividends..............................................
- Preferred stock dividends..............................................
Free cash flow...............................................................

b. Free cash flow represents the funds that are available for special financial activities,
such as a leveraged buyout.

11. Amigo Software, Inc., has total assets of $800,000, current liabilities of $150,000, and long-
term liabilities of $120,000. There is $65,000 in preferred stock outstanding. Thirty thousand
shares of common stock have been issued.
a. Compute book value (net worth) per share.
b. If there is $48,000 in earnings available to common stockholders and the firm’s stock has
a P/E of 20 times earnings per share, what is the current price of the stock?
c. What is the ratio of market value per share to book value per share? to the right of the
decimal point.)

Answer
Amigo Software, Inc.
a. Total assets ......................................................................
–Current liabilities...........................................................
–Long-term liabilities.......................................................
Stockholders’ equity.....................................................
–Preferred stock...............................................................
Net worth assigned to common.....................................
Common shares outstanding.........................................
Book value (net worth) per share..................................

b. Earnings available to common.........................................

Shares outstanding...........................................................
Earnings per share............................................................

………………………………………………………………..
....................................................................................................
c. Market value per share (price) to book value per share..............................................

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12-For December 31, 2024, the balance sheet of Baxter Corporation was as follows:
Current Assets Liabilities
Cash............................................. $ 10,000 Accounts payable................ $ 12,000
Accounts receivable.................... 15,000 Notes payable...................... 20,000
Inventory..................................... 25,000 Bonds payable..................... 50,000
Prepaid expenses......................... 12,000
Fixed Assets Stockholders’ Equity
Plant and equipment (gross)….... $250,000 Preferred stock.................... 20,000
Less: Accumulated................... Common stock.................... 55,000
depreciation.............................. 50,000 Paid-in capital..................... 25,000
Net plant and equipment............. 200,000 Retained earnings ............... 80,000
..................................................... Total liabilities and
Total Assets................................. $262,000 stockholders’ equity............ $262,000

Sales for 2025 were $220,000, and the cost of goods sold was 60 percent of sales. Selling
and administrative expense was $22,000. Depreciation expense was 8 percent of plant and
equipment (gross) at the beginning of the year. Interest expense for the notes payable was 10
percent, while the interest rate on the bonds payable was 12 percent. This interest expense is
based on December 31, 2024 balances. The tax rate averaged 20 percent.
Two thousand dollars in preferred stock dividends were paid and $8,400 in dividends
were paid to common stockholders. There were 10,000 shares of common stock outstanding.
During 2025, the cash balance and prepaid expenses balances were unchanged. Accounts
receivable and inventory increased by 10 percent. A new machine was purchased on December
31, 2024, at a cost of $35,000.
Accounts payable increased by 25 percent. Notes payable increased by $6,000 and bonds
payable decreased by $10,000, both at the end of the year. The preferred stock, common stock,
and paid-in capital in excess of par accounts did not change.

a. Prepare an income statement for 2025.

b. Prepare a statement of retained earnings for 2025.
c. Prepare a balance sheet as of December 31, 2025.
Answer
Baxter Corporation
2025 Income Statement
a. Sales .....................................................................................
Cost of good sold (60%).......................................................
Gross profit..................................................................
Selling and administrative expense......................................
Depreciation expense (8%)..................................................
Operating profit (EBIT)..............................................
Interest expense ....................................................................
Earnings before taxes...................................................
Taxes (20%)..........................................................................
Earnings after taxes (EAT)..........................................
Preferred stock dividends.....................................................
Earnings available to common stockholder..........................
Shares outstanding................................................................
Earnings per share................................................................

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b. 2025 Statement of Retained Earnings

Retained earnings balance, January 1, 2025.........................

Add: Earnings available to common stockholders, 2025......
Deduct: Cash dividend declared in 2025...............................
Retained earnings balance, December 31, 2025...........

c. Baxter Corporation
2024 Balance sheet
Current Assets
Cash.............................................…………........
Accounts receivable…………………………….
Inventory ……............................…………........
Prepaid expenses.........................…………........
Total current assets........................................
Fixed Assets
Plant and equipment (gross)………………….…
Less: Accumulated
Depreciation ………………. ………
Net plant and equipment.........……………….
Total Assets.................................……………….

Liabilities
Accounts payable …...................………………
Notes payable .............................………………
Bonds payable.............................………………
Total................................................................
Stockholders’ Equity
Preferred stock…………………………………
Common stock............................……………...
Paid-in capital...............................……………...
Retained earnings ........................……………...
Total liabilities and
stockholders’ equity.................……………...

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13. Prepare a statement of cash flows for the Jeter Corporation.

JETER CORPORATION
Income Statement
For the Year Ended December 31, 2025

Sales.......................................................................................... $ 3,300,000
Cost of goods sold..................................................................... 1,950,000
Gross profits........................................................................ 1,350,000
Selling and administrative expense........................................... 650,000
Depreciation expense................................................................ 230,000
Operating income................................................................ 470,000
Interest expense......................................................................... 80,000
Earnings before taxes.......................................................... 390,000
Taxes......................................................................................... 140,000
Earnings after taxes............................................................. 250,000
Preferred stock dividends............................................................ 10,000
Earnings available to common stockholders............................. $ 240,000
Shares outstanding.................................................................... 150,000
Earnings per share..................................................................... $ 1.60
Statement of Retained Earnings
For the Year Ended December 31, 2025
Retained earnings, balance, January 1, 2025............................ $800,000
Add: Earnings available to common stockholders, 2025....... 240,000
Deduct: Cash dividends declared and paid in 2025............... 140,000
Retained earnings, balance, December 31, 2025...................... $900,000

Comparative Balance Sheets

For 2024 and 2025
Year-End Year-End
Assets 2024 2025
Current assets:
Cash..................................................................................... $ 100,000 $120,000
Accounts receivable (net)................................................... 500,000 510,000
Inventory............................................................................. 610,000 640,000
Prepaid expenses................................................................. 60,000 30,000
Total current assets....................................................... 1,270,000 1,300,000
Investments (long-term securities)...................................... 90,000 80,000
Plant and equipment............................................................ 2,000,000 2,600,000
Less: Accumulated depreciation................................... 1,000,000 1,230,000
Net plant and equipment..................................................... 1,000,000 1,370,000
Total assets................................................................................ $2,360,000 $2,750,000

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Year-End Year-End
Liabilities and Stockholders’ Equity 2024 2025
Current liabilities:
Accounts payable................................................................ $ 300,000 $ 550,000
Notes payable...................................................................... 500,000 500,000
Accrued expenses................................................................ 70,000 50,000
Total current liabilities..................................................... 870,000 1,100,000
Long-term liabilities:
Bonds payable..................................................................... 100,000 160,000
Total liabilities................................................................. 970,000 1,260,000
Stockholders’ equity:
Preferred stock, $100 par value.......................................... 90,000 90,000
Common stock, $1 par value.............................................. 150,000 150,000
Capital paid in excess of par............................................... 350,000 350,000
Retained earnings................................................................ 800,000 900,000
Total stockholders’ equity................................................ 1,390,000 1,490,000
Total liabilities and stockholders’ equity.................................. $2,360,000 $2,750,000

Answer
Jeter Corporation
Statement of Cash Flows
For the Year Ended December 31, 2025
Cash flows from operating activities:
Net income (earnings after taxes)
Adjustments to determine cash
flow from operating activities:
Add back depreciation
Increase in accounts receivable
Increase in inventory
Decrease in prepaid expenses
Increase in accounts payable
Decrease in accrued expenses
Total adjustments
Net cash flows from operating
activities
Cash flows from investing activities:
Decrease in investments
Increase in plant and equipment
Net cash flows from investing
activities
Cash flows from financing activities:
Increase in bonds payable
Preferred stock dividends paid
Common stock dividends paid
Net cash flows from financing
Net increase (decrease) in cash flows

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14. From the following balance sheet information and other data, prepare a statement of cash
flows for Brown Company, using the indirect method:
12/31/2024 12/31/2025
Cash $ 1,800 $ 2,830
Marketable securities 1,600 1,730
Accounts Receivable 3,050 2,950
Prepaid Insurance 4,310 5,490
Land 2,000 3,500
Machinery 6,060 6,240
Accumulated Depreciation (1,070) (1,390)
Patents 200 160
Total Assets $17,950 $21,510
Wages Payable $ 5,630 $ 6,040
Note Payable (Long-term) — 1,500
Bonds Payable 2,100 1,600
Deferred Taxes Payable 300 410
Common Stock 1,000 1,000
Preferred Stock 4,000 4,300
Paid-in Capital in Excess of Par—Preferred 1,750 2,260
Retained Earnings 3,340 4,400
Treasury Stock (170) —
Total Liabilities and Stockholders’ Equity $17,950 $21,510

Other data:
(1) Net income $1,490
(2) Depreciation expense 530
(3) Loss on sale of machinery 50
(4) Amortization of patents 40
(5) Dividends paid (cash) 430
(6) Machinery with a cost of $450 and a book value of $240 was sold for $190.
(7) Machinery was purchased for $630.
(8) Treasury stock was sold for $250 cash.
(9) Land with a fair market value of $1,500 was purchased by the issuance of a long-
term note payable.
(10) Preferred stock was issued for $230 cash.
(11) The remaining changes in the Preferred Stock account and in the Paid-in-Capital
in Excess of Par account resulted from the issuance of preferred stock to retire
$500 of bonds payable.

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Answer

Brown Company
Statement of Cash Flows
For the Year Ended December 31, 2025

CASH FROM OPERATING ACTIVITIES

Net Income...............................................................
Depreciation Expense...............................................
Loss on Sale of Machinery.......................................
Amortization of Patents............................................
Change in Accounts Receivable...............................
Change in Prepaid Insurance....................................
Change in Wages Payable........................................
Change in Deferred Tax Liability.............................
Net Cash Flow from Operations...................
CASH FROM INVESTMENT ACTIVITIES
Sale of machinery.....................................................
Purchase of machinery..............................................
Purchase of marketable securities.............................
Net Cash Flow from Investment Activities...
CASH FROM FINANCE ACTIVITIES
Cash dividends paid..................................................
Sale of treasury stock................................................
Issuance of preferred stock.......................................
Net Cash Flow from Finance Activities........
Cash increase.........................................................................

15. Delaney, Inc. sells minicomputers. During the past year, the company's sales were $4
million. The cost of its merchandise sold came to $2 million, cash operating expenses were
$400,000, depreciation expense was $100,000, and the firm paid $150,000 in interest on bank
loans. Also, the corporation paid $25,000 in the form of dividends to its own common
stockholders.
a. Calculate the corporation's tax liability (use table2-12)
b. Calculate average tax rate and marginal tax rate based up your finding
Answer
Delaney, Inc. - Corporate Income Tax

Sales....................................................................
Cost of goods sold...............................................
Gross profit..........................................................
Cash operating expenses.....................................
Depreciation expense..........................................
Operating profit..................................................
Interest expense..................................................
Taxable Income..................................................

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a- Tax liabilities
Taxable Income x Marginal Taxes Rate = Taxes Liabilities
...........................................................................................................................................................
...........................................................................................................................................................
...........................................................................................................................................................
...........................................................................................................................................................
...........................................................................................................................................................
...........................................................................................................................................................
..........................................................................................................................................................

b- Calculate average tax rate and Marginal Taxes Rate

...........................................................................................................................................................
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