Tombert Company is a manufacturer of computers. Its controller resigned in October 2010. An inexperienced assistant accountant has prepared the following income statement for the month of October 2010.

Prior to October 2010 the company had been profitable every month.The company’s president is concerned about the accuracy of the income statement. As her friend, you have been asked to review the income statement and make necessary corrections. After examining other manufacturing cost data, you have acquired additional information as follows.

1. Inventory balances at the beginning and end of October were:

2. Only 70% of the utilities expense and 60% of the insurance expense apply to factory operations. The remaining amounts should be charged to selling and administrative activities.

Instructions

(a) Prepare a schedule of cost of goods manufactured for October 2010.

(b) Prepare a correct income statement for October 2010.

Reporting Equity Income, Noncontrolling Interest, and Pension Information – (Based on the Other Topics section.) A partial income statement for Half Moon, Inc. is reported below.

In addition, the following disclosure was found in the notes to the financial statements.

Required Explain each of the following.

A. What information is conveyed by the line labeled “Equity income in related company”? Describe the situation that must prevail for this line to appear on an income statement.

B. What information is conveyed by the line labeled “Noncontrolling interest in net income of subsidiary”? Describe the situation that must prevail for this line to appear on an income statement. Why is this amount subtracted in this case?

C. What information is conveyed by each of the first three lines of Note 7?

D. What information is conveyed by each of the second set of three lines of Note 7?

In this exercise, you will explore PERT and the three-point estimates in the Estimating Worksheet you used in the last exercise.

In the Estimating Worksheet that you completed in Exercise 1 of this chapter, navigate to the worksheet called “3 Point Estimate.” This worksheet is based on the entries you made in Exercise 1. You will also use the worksheets in this file called “PERT” and “PERT versus 3 Point.”

1. What is the three-point estimate result for Ruth Carze on this entry?
2. Navigate to the worksheet titled “PERT.” This worksheet is based on the values you’ve entered on the “Time cost analysis” worksheet.
3. What is the PERT result for Ruth Carze?
4. Return to the “Time cost analysis” worksheet and change the optimistic values for Ruth Carze to 20.
5. Compare the three-point result and the PERT result for Ruth Carze with this new optimistic value.
6. Navigate to the worksheet titled “PERT versus 3 Point.”
7. On this worksheet there are two charts that will compare the results of the three-point estimate and PERT. Hover your mouse over the first bar that represents Paul Samms in the 3 Point Estimate chart. What is the value that’s displayed?
8. Now hover your mouse over the first bar that represents Paul Samms in the PERT Estimate chart. What is the value that’s displayed?

9. Why is there a difference between the PERT value and the three-point value?

(Learning Objective 1: Evaluating the components of income) Prudhoe Bay Oil Co. is having its initial public offering (IPO) of company stock. To create public interest in its stock, Prudhoe Bay’s chief financial officer has blitzed the media with press releases. One, in particular, caught your eye. On November 19, Prudhoe Bay announced unaudited earnings per share (EPS) of $1.19, up 89% from last year’s EPS of $0.63. An 89% increase in EPS is outstanding! Before deciding to buy Prudhoe Bay stock, you investigated further and found that the company omitted several items from the determination of unaudited EPS, as follows:

• Unrealized loss on available-for-sale investments, $0.06 per share

• Gain on sale of building, $0.05 per share

• Prior-period adjustment, increase in retained earnings $1.10 per share

• Restructuring expenses, $0.29 per share

• Loss on settlement of lawsuit begun 5 years ago, $0.12 per share

• Lost income due to employee labor strike, $0.24 per share

• Income from discontinued operations, $0.09 per share

Wondering how to treat these “special items,” you called your stockbroker at Merrill Lynch. She thinks that these items are nonrecurring and outside Prudhoe Bay’s core operations. Furthermore, she suggests that you ignore the items and consider Prudhoe Bay’s earnings of $1.19 per share to be a good estimate of long-term profitability.Required

What EPS number will you use to predict Prudhoe Bay’s future profits? Show your work, and explain your reasoning for each item.

(Learning Objective 1, 3: Evaluating the quality of earnings, valuing investments, and

analyzing stock outstanding) This case is based on the Pier 1 Imports financial statements in Appendix B at the end of this book.

1. Pier 1’s income statement reports only 1 special item. What is it, and what is its amount for 2006?

2. What is your evaluation of the quality of Pier 1’s earnings? State how you formed your opinion.

3. At the end of 2005, how much would you have been willing to pay for 1 share of Pier 1 stock if you had rated the investment as high risk? as low risk? Use even-numbered investment capitalization rates in the range of 6%–12% for your analysis, and use basic earnings per share for continuing operations.

4. Go to Pier 1’s Web site and get the current price of a share of Pier 1 Imports’ common stock. Which value that you estimated in requirement 2 is closest to Pier 1’s actual stock price? (Challenge)

(Learning Objective 3: Using a statement of stockholders’ equity) Datacom Services, Inc., reported the following statement of stockholders’ equity for the year ended October 31, 20X7.

Required

Answer these questions about Datacom Services’ stockholders’ equity transactions:

1. The income tax rate is 40%. How much income before income tax did Datacom report on the income statement?

2. What is the par value of the company’s common stock?

3. At what price per share did Datacom Services issue its common stock during the year?

4. What was the cost of treasury stock sold during the year? What was the selling price of the treasury stock sold? What was the increase in total stockholders’ equity?

5. Datacom Services’ statement lists the stock transactions in the order they occurred. What was the percentage of the stock dividend?

Select a company and research its business. Search the business press for articles about this company. Obtain its annual report by requesting it directly from the company or from the company’s Web site or from Moody’s Industrial Manual (the exercise will be most meaningful if you obtain an actual copy and do not have to use Moody’s).

Required

1. Based on your group’s analysis, come to class prepared to instruct the class on 6 interesting facts about the company that can be found in its financial statements and the related notes. Your group can mention only the obvious, such as net sales or total revenue, net income, total assets, total liabilities, total stockholders’ equity, and dividends, in conjunction with other terms. Once you use an obvious item, you may not use that item again.

2. The group should write a paper discussing the facts that it has uncovered. Limit the paper to 2 double-spaced word-processed pages.

On 8 May 2009, Toyota Motor Company, the world’s largest automobile manufacturer, announced that it was going to cut its dividend for the first time. Toyota, which pays dividends twice a year, said the dividend would be reduced to ¥35 a share from the ¥75 paid a year earlier. The 2008 total dividend was ¥140 a share. The dividend cut ends a 600 percent cumulative increase in the dividend over 10 years. Faced with plunging global demand for cars (Toyota’s vehicle sales were forecasted to fall 14 percent) and ongoing turmoil in the auto industry, Toyota was expecting a loss as high as ¥550 billion (operating loss of ¥850 billion) for fiscal year ending March 2010, compared with the analyst forecast loss of ¥284 billion for the same period. The company already had a loss of ¥437 billion in fiscal year 2009 (the operating loss was ¥461 billion). Toyota is focused on aggressively cutting costs—it plans to cut production-related costs by ¥340 billion and fixed costs by ¥460 billion—and has said that the lower dividend is because of the difficulty of sustaining the dividend at its previous level. Board member bonuses have been eliminated and manager summer bonuses were reduced by 60 percent. Capital spending will be cut by 36 percent to ¥830 billion, and R&D spending will be cut by 9.3 percent to ¥820 billion.

The company announced plans to raise capital via a bond issue of as much as ¥700 billion. Standard & Poor’s cut Toyota’s bond rating from AA+ to AA. Another problem facing Toyota and other Japanese automakers is the strong yen, which has gained 13 percent against the U.S. dollar in the preceding quarter. Toyota said that a one yen gain against the dollar trims profits by about ¥30 billion and that a similar gain against the euro trims profits by ¥4 billion.

Discuss Toyota’s decision to cut its dividend in light of the factors affecting dividend policy covered in this section.

1. An individual investor pays taxes of 28 percent on the next dollar of dividend income and taxes of 15 percent on the next dollar of capital gains. Which would she prefer: $1 in dividends or $0.87 in capital gains?

2. Suppose the tax rate on capital gains is 20 percent for all investors but the tax rate on dividend income differs among investors. A share drops by 70 percent of the amount of the dividend, on average, when the share goes ex-dividend. Assume that any appropriate corrections for equity market price movements on ex-dividend days have been made. Calculate the marginal tax rate on dividend income applying to those who trade the issue around the ex-dividend day.

3. Consider a U.S. corporation with a corporate income tax rate of 40 percent. The corporation needs to report as taxable income only 30 percent of dividends received from other corporations—that is, it takes a 70 percent deduction on that type of dividend income in calculating taxes owed. Assume that both capital gains and reported dividends (dividends net of any deductible amount) are taxed at 40 percent. What is $1 of dividends worth in terms of capital gains for such a corporate investor?

4. Explain why the ex-dividend share price would be expected to drop by more than the amount of the dividend if such investors as the corporation described in question 3 are the marginal trader in the issue.

5. For a given share issue, the share price consistently drops by an amount very close to the amount of the dividend when the share goes ex-dividend. Describe the marginal investor in the shares.

Norwegian Salmon Processing Facility, Trondheim

NorSal Trondheim operates a salmon processing facility where fish are purchased from local sources along the North Sea, processed at the facility, and sold to customers for distribution. The plant manager, Inger Hansen, is contemplating a plant modernization to upgrade the technology in the plant. While the plant performs well enough now, modernizing equipment would allow the plant to increase capacity per hour, which is particularly advantageous because the factory has enough demand to cover the additional capacity. Currently, the plant operates five days a week, in two shifts of 30 workers per shift. The workers are paid $10 per hour. Adding a third shift is not possible because the plant is cleaned during the third shift.

The firm is contemplating a plant modernization to upgrade existing equipment, which should increase the plant’s output while lowering energy costs. Using the current equipment, around 1,500 pounds of salmon can be processed each hour, while the new plant would be able to process 2000, pounds per hour. The updated equipment is made by the same manufacturer as the existing equipment, and the production personnel feel that they will be able to learn to use the new equipment quickly. For this reason, costs to train personnel are assumed to be negligible. The production manager, Bjorn Pedersen, is skeptical about undergoing the plant modernization, The older equipment, he argues, is already paid for, and new equipment would cost $10,000 per week, This cost is comprised of both principal and interest, and includes manufacturer installation of the equipment The controller, Maret Karlsen, cautions that all decisions related to costs should be included in the analysis and that because the energy consumption would be different, this must also be accounted for in the decision. Energy costs are presently $10 per unit, and the existing plant uses 1,000 units of energy per week. With the modernized plant, the consumption of energy would fall by 50%.

Discussion Questions

1. What is the productivity of the processing facility, with the equipment currently in use?

2. What would the productivity of the plant become if the new system were purchased and implemented?

3. What would be the amount of additional expense on equipment that would make productivity of the two systems equal?

4. What might happen if energy costs increase in the future?