26 Jan 2. Low and falling profits

P 9-9

Assume the following facts for the current year:

Net income $200,000

Common dividends $ 20,000

Preferred dividends (The preferred stock is not convertible.) $ 10,000

Common shares outstanding on January 1 20,000 shares

Common stock issued on July 1 5,000 shares

2-for-1 stock split on December 31

Required

a. Compute the earnings per share for the current year.

b. Earnings per share in the prior year was $8.00. Use the earnings per share computed in

(a) and present a two-year earnings per share comparison for the current year and the

prior year.

P 9-10

Smith and Jones, Inc. is primarily engaged in the worldwide production, processing,

distribution, and marketing of food products. The following information is from its 2011

annual report:

2011 2010

Earnings per share $ 1.08 $ 1.14

Cash dividends per common share $ 0.80 $ 0.76

Market price per common share $ 12.94 $ 15.19

Common shares outstanding 25,380,000 25,316,000

Total assets $1,264,086,000 $1,173,924,000

Total liabilities $ 823,758,000 $ 742,499,000

Nonredeemable preferred stock $ 16,600,000 $ 16,600,000

Preferred dividends $ 4,567,000 $ 930,000

Net income $ 32,094,000 $ 31,049,000

Required

a. Based on these data, compute the following for 2011 and 2010:

1. Percentage of earnings retained

2. Price/earnings ratio

3. Dividend payout

4. Dividend yield

5. Book value per share

b. Discuss your findings from the viewpoint of a potential investor.

P 9-14

Answer the following multiple-choice questions:

a. In 2009 and 2010, Zoret Company reported earnings per share of $0.80 and $1.00, respectively.

In 2011, Zoret Company declared a 4-for-1 stock split. For the year 2011, Zoret

Company reported earnings of $0.30 per share. The appropriate earnings per share presentation

for a three-year comparative analysis that includes 2009, 2010, and 2011 would be

2011 2010 2009

1. $0.30 $0.25 $0.80

2. $0.30 $4.00 $3.20

3. $0.30 $0.25 $0.20

4. $1.20 $0.25 $0.20

5. $1.20 $4.00 $3.20

b. The degree of financial leverage for Zorro Company was 1.50 when EBIT was reported at

$1,000,000. If EBIT goes to $2,000,000, the accompanying change in net income will be

1. $2,500,000.

2. $3,000,000.

3. $2,000,000.

4. $1,500,000.

5. $1,000,000.

c. In 2012, Zello Company declared a 10% stock dividend. In 2011, earnings per share

was $1.00. When the 2011 earnings per share is disclosed in the 2012 annual report, it

will be disclosed at

1. $1.00.

2. $1.10.

3. $1.20.

4. $0.91.

5. $0.81.

d. Which of the following ratios usually reflects investors’opinions of the future prospects

for the firm?

1. Dividend yield

2. Book value per share

3. Price/earnings ratio

4. Earnings per share

5. Dividend payout

e. Which of the following ratios gives a perspective on risk in the capital structure?

1. Book value per share

2. Dividend yield

3. Dividend payout

4. Degree of financial leverage

5. Price/earnings ratio

f. The earnings per share ratio is computed for

1. Convertible bonds.

2. Redeemable preferred stock.

3. Common stock.

4. Nonredeemable preferred stock.

5. None of the above.

g. Increasing financial leverage can be a risky strategy from the viewpoint of stockholders

of companies having

1. Steady and high profits.

2. Low and falling profits.

3. Relatively high and increasing profits.

4. A low debt/equity ratio and relatively high profits.

5. None of the above.