Universitas Pelita Harapan Medan (UPH)

Medan Campus Financial Statement Analysis (FSA)

SUPPLEMENT MATERIAL
FOR
CHAPTER 6 – ANALYZING OPERATING ACTIVITIES

Problem 4 – Accounting for Income Tax Expenses

Playgrounds, Inc., is granted a distribution franchise by Shady Products in Year 1. Operations are profitable until Year
4 when some of the company’s inventories are confiscated and large legal expenses are incurred. Playgrounds’ tax
rate is 50% each year (all expenses and costs are tax deductible). Relevant income statement data are (in thousands):
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8
Sales $ 50 $ 80 $ 120 $ 100 $ 200 $ 400 $ 500 $ 600
Cost of
Goods Sold 20 30 50 300 50 120 200 250
General and
administrative 10 15 20 100 20 30 40 50
Pretax
Income $ 20 $ 35 $ 50 $ (300) $ 130 $ 250 $ 260 $ 300

Required:
Compute tax expense for each of the Year 1 through 8, and present comparative income statement for these years
(assume a 3-year carryback period, a 20 year carry forward period for any losses, and a 100% valuation allowance for
the loss carry forward).
Problem 5 – Earnings per Share Computations
A WRESTLING FEDERATION OF AMERICA, INC.
Capital Structure and Earnings for Year 7
Number of common shares outstanding on December 31, Year 7 2,700,000
Number of common shares outstanding during Year 7 (weighted average) 2,500,000
Market price per common share on December 31, Year 7 $ 25
Weighted-average market price per share during Year 7 $ 20

Options outstanding during Year 7:

Number of shares issuable on exercise of options 200,000
Exercise price $ 15

Convertible bonds outstanding (December 31, Year 3, issue date):

Number of convertible bonds 10,000
Shares of common issuable on conversion (per bond) 10
Coupon rate 5.0%
Proceeds per bond at issue (at par value) $ 1,000

Net income for Year 7 $6,500,000

Tax rate for Year 7 40%

Required: Determine Basic EPS and Diluted EPS for Year 7.

From the desk of Ciptawan 1

Universitas Pelita Harapan Medan (UPH)
Medan Campus Financial Statement Analysis (FSA)

Problem 6 - Computing Earnings per Share

Ace Company’s net income for the year is $4 million and the number of common shares outstanding is 3 million (there
is no change in shares outstanding during the year). Ace has options and warrants outstanding to purchase 1 million
common shares at $15 per share.
Required:
a) If the average market value of the common share is $20, year-end price is $25, interest rate on borrowings is
6%, and the tax rate is 50%, then compute both basic and diluted EPS.
b) Do the same computations as in a assuming net income for the year is only $3 million, the average market
value per common share is $18, and year-end price is $20 per share.

From the desk of Ciptawan 2