E5-25.

a.
($ millions)
McDonalds [$4,758 + $571 x (1-.35)] / $35,454 = 14.47%
Yum! Brands [($1,021 + $130 x (1-.35)] / $8,520 = 12.98%

b.
($ millions) PM = EWI / Sales AT = Sales / Avg. Assets
McDonalds [$4,758 + $571 x (1-.35)] / $27,441 = $27,441 / $35,454
18.69% = 0.774

Yum! Brands [($1,021 + $130 x (1-.35)] / $13,279 $13,279 / $8,520

= 8.33% = 1.559

c. McDonalds ROA is greater than Yum! Brands in fiscal 2014. Yum! Brands value
pricing strategy is clearly evident in its lower PM, but this is partially offset by a
higher asset turnover. For both firms, asset turnover is influenced by franchising and
leasing of retail stores.

E5-27.

($
CVS Walgreen
millions)
a. EWI $4,644 + $600 x (1-.35) = $5,034 $2,031 + $156 x (1-.35) =
$2,132.4
Avg. ($74,252 + $71,526)/2 = $72,889 ($37,182 + $35,481) /2 =
Assets $36,331.5
ROA $5,034/ $72,889 = 6.90% $2,132.4/ $36,331.5 = 5.87%

b. PM $5,034/$139,367 = 3.61% $2,132.4/$76,392 = 2.79%

AT $139,367/$72,889 = 1.91 $76,392/$36,331.5 = 2.10

c. Avg. Equity ($37,963 + $37,938)/2 = $37,950.5 ($20,561 + $19,454)/2 =

$20,007.5
ROE $4,644 / $37,950.5 = 12.24% $2,031 / $20,007.5 = 10.15%
ROFL 12.24% - 6.90% = 5.34% 10.15% - 5.87% = 4.28%

d. Walgreens ROE and ROA are lower than CVSs. CVSs PM is slightly higher than
Walgreens, but its AT is lower. The low PMs for both companies reflect the highly
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Solutions Manual, Chapter 5 5-1
 competitive retail pharmaceutical industry. CVS has a slight advantage in 2014 due
to its effective use of financial leverage. Asset turnover and ROA differences would
have to be examined further, because both companies use operating leases that do
not show up on its balance sheet. Chapter 10 looks at this important topic.

E5-32.

a. ($ millions) Current Ratio

2012 $19,991 / $16,714 = 1.20
2013 $14,075 / $18,912 = 0.74
2014 $13,531 / $17,410 = 0.78

In 2013, Comcasts current ratio dropped well below 1.0 and remained about the
same in 2014. Consequently, it does not appear to be very liquid. While the current
ratio provides a useful point estimate of liquidity, it would be helpful to know when
the cash flows from current assets will be realized and when the current liabilities will
need to be paid. Current assets dropped almost 30% between 2012 and 2013, while
current liabilities increased. The change in current assets was due to a decrease in
cash, which is troubling on the surface. However, by examining the cash flow
statement, we find that operating cash flow was relatively stable and the big cash
expenditure in 2013 was the $10 billion acquisition of outstanding noncontrolling
interest in NBC Universal (shares of NBC Universal held by minority shareholders
see chapter 12).

b. ($ millions) Times interest earned Debt-to-equity

($164,971 - $49,796) / $49,796
$(11,609 + 2,521) / $2,521 = 5.6
2012 = 2.31

($158,813 - $51,058) / $51,058

$(11,115 + 2,574) / $2,574 = 5.3
2013 = 2.11

($159,339 - $53,068) / $53,068

$(12,465 + 2,617) / $2,617 = 5.8
2014 = 2.00

Both measures of solvency the times interest earned ratio and the debt to equity
ratio improved slightly in 2014. This is probably due to increasing profits and the
favorable interest rate environment in these years. Comcast is able to cover its
interest expense by a margin that is above the median for the industry, but its debt-
to-equity ratio is higher than the median.

c. Comcasts current ratio is significantly lower than the industry median and bears
watching. At present, Comcast is able to cover its interest expense by a margin that

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5-2 Financial Accounting, 5th Edition
 exceeds the median for the industry. Comcasts debt-to-equity ratio is relatively high
and is above the industry median.

d. Comcast has a relatively high level of debt and appears to have a low level of
liquidity. However, its increasing profitability and interest coverage that is above the
industry median provide some reassurance that it will be able to service its liabilities
and continue to make further investments.

E5-34.
($ millions)

a. EWI $1,262 + $75 x (1-.35) = $1,310.75

Avg. Equity ($2,983 + $3,062) / 2 = $3,022.5
Avg. Assets ($7,690 + $7,849) / 2 = $7,769.5
ROE $1,262 / $3,022.5 = 41.8%
ROA $1,310.75 / $7,769.5 = 16.9%
ROFL 41.8% - 16.9% = 24.9%

b. PM $1,310.75 / $16,435 = 7.98%

AT $16,435 / $7,769.5 = 2.12

c. GPM $6,289 / $16,435 = 38.3%

INVT $10,146 / [($1,889 + $1,928) / 2] = 5.32

d. The Gap showed strong performance in the year ended January 31, 2015 (hereafter,
2014), though not quite as strong as 2013. Its ROA was 16.9%, which is high for the
retail industry. ROE was over 41% indicating the effective use of financial leverage.
Interest costs were low, suggesting that most of The Gaps debt is from operating
liabilities (accounts payable and accrued expenses). Its profit margin and asset
turnover ratios place The Gap in a strong position for this industry.

The GPM and INVT ratios are two important performance measures for retail
companies such as The Gap. GPM measures the ability of the firm to sell its
merchandise at reasonable margins while INVT provides evidence on inventory
management and the popularity of its product line. Both measures are near the
median for retailers in 2014.

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Solutions Manual, Chapter 5 5-3
P5-38. (45 minutes)

($ millions) Home Depot Lowes

a. EWI $6,345 + $830 x (1-.35) = $6,884.5 $2,698 + $522 x (1-.35) = $3,037.3

Avg. Equity ($9,322 + $12,522) / 2 = $10,922 ($9,968 + $11,853) / 2 = $10,910.5

Avg. Assets ($39,946 + $40,518) / 2 = $40,232 ($31,827 + $32,732) / 2 = $32,279.5

ROE $6,345 / $10,922 = 58.1% $2,698 / $10,910.5 = 24.7%

ROA $6,884.5 / $40,232 = 17.1% $3,037.3 / $32,279.5 = 9.4%

ROFL 58.1% - 17.1% = 41.0% 24.7% - 9.4% = 15.3%

In 2014, Home Depots profitability exceeded that of Lowes, both in return to

shareholders and in return on assets. Home Depot also had a much larger
proportional effect from the use of leverage.
b. PM $6,884.5 / $83,176 = 8.27% $3,037.3 / $56,223 = 5.40%

AT $83,176 / $40,232 = 2.07 $56,223 / $32,279.5 = 1.74

Home Depot has a higher PM ratio, so it makes more money for every dollar of
sales, and it also generates more sales for every dollar of resources, suggesting that
it is managing assets more efficiently.
c. GPM $28,954 / $83,176 = 34.81% $19,558 / $56,223 = 34.79%

Operating ETS ($16,834 + $1,651) / $83,176 = 22.2% ($13,281 + $1,485) / $56,223 = 26.3%

These two companies have identical gross profit margins. The Home Depots GPM
ratio is slightly higher than that of Lowes, and its operating ETS ratio is lower.
Overall, Home Depot performed slightly better with respect to these two profitability
measures.
d. ART $83,176 / $[(1,484 + 1,398)/2] = 57.72 $56,223 / 0 = N/A

INVT $54,222 / $[(11,079 + 11,057)/2] = 4.90 $36,665 / $[(8,911 + 9,127)/2] = 4.07

PPET $83,176 / $[(22,720 + 23,348)/2] = 3.61 $56,223 / $[(20,034 + 20,834)/2] = 2.75

Lowes reports no accounts receivable and Home Depot reports very small amounts
of receivables. Neither company relies on customer credit to generate sales, so the
ART ratio is not very informative. More important is the INVT ratio. Home Depots
INVT is higher than Lowes ratio. The same is true for the PPET ratio. These
differences are consistent with the difference in the AT ratios noted earlier. Overall,
the numbers suggest that Home Depot is managing inventories and PPE assets
more efficiently.
e. Overall, It appears that Home Depot performed better than Lowes in 2014. Its ratio
values are either equal to or better than Lowes in almost every category.

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5-4 Financial Accounting, 5th Edition
P5-39. (30 minutes)

($ millions) Home Depot Lowes

a. Current Ratio 2014: $15,302 / $11,269 = 1.36 $10,080 / $9,348 = 1.08
2013: $15,279 / $10,749 = 1.42 $10,296 / $8,876 = 1.16

Quick Ratio 2014: ($1,723 + $1,484) / $11,269 = 0.285 ($466 + $125) / $9,348 = 0.063
2013: ($1,929 + $1,398) / $10,749 = 0.310 ($391 + $185) / $8,876 = 0.065

Both companies current ratios are above one, though Home Depots is a bit higher.
Quick ratios are very low due to the lack of receivables and low cash balances. Both
companies rely on operating cash flow to cover liquidity needs. Given the lack of
receivables, the INVT ratio becomes doubly important (see P5-38). Failure to turn
inventories quickly would result in lower operating cash flow and liquidity problems.
Hence, both companies emphasize inventory management.

b. TIE 2014: ($9,976 + $830)/$830 = 13.02 ($4,276 + $522)/$522 = 9.19

2013: ($8,467 + $711)/$711 = 12.91 ($3,673 + $480)/$480 = 8.65

Debt-to-Equity 2014: $30,624 / $9,322 = 3.29 $21,859 / $9,968 = 2.19

2013: $27,996 / $12,522 = 2.24 $20,879 / $11,853 = 1.76

For both companies, the debt-to-equity ratio increased from 2013 to 2014 indicating
more reliance on debt financing. Both are higher than the median for the retail industry.
Despite this trend, both companies TIE ratios increased.

c. The Home Depot utilizes more debt financing than does Lowes though both are higher
than the median retail firm. This results in a higher ROFL (see P5-38), as well as higher
debt-to-equity. Both firms have TIE ratios that are above the median for the retail
industry.

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Solutions Manual, Chapter 5 5-5