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Chapter 2: 6DQ (page 46)

Comment on why inflation may restrict the usefulness of the balance sheet as normally presented.

Short Answer

Expert verified

Inflation in an economy affects the balance sheet values of the company, as inflation results in an increase in the fair value of the fixed assets. However, the values in the balance sheet are shown on a historical basis.

Step by step solution

01

Inflation

Inflation is defined as the progressive increase in the price of the products and services in the economyand a decrease in the purchasing power of the given currency over the period.

02

Balance sheet

A balance sheet is a major component of the financial statements of the company.It is prepared to show the position of the company鈥檚 assets, liabilities and the company鈥檚 fund at the end of the reporting period.When there exists inflation, the balance may not represent the true values of its items. As a result, its usefulness gets restricted.

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Most popular questions from this chapter

Nova Electrics anticipates cash flow from operating activities of \(6 million in 20X1. It will need to spend \)1.2 million on capital investments to remain

competitive within the industry. Common stock dividends are projected at

\(.4 million and preferred stock dividends at \).55 million.

a. What is the firm鈥檚 projected free cash flow for the year 20X1?

b. What does the concept of free cash flow represent?

The Sterling Tire Company鈥檚 income statement for 20X1 is as follows:

STERLINE TIRE COMPANY

Income Statement

For the year ended December 31, 20X1

Sales (20,000 tires at \(60 each)

\)1,200,000

Less: variable costs (20,000 tires at \(30)

600,000

Less: fixed cost

400,000

Earnings before interest and taxes (EBIT)

\)200,000

Interest expenses

50,000

Earning before taxes (EBT)

\(150,000

Income tax expenses (30%)

45,000

Earning after taxe (EAT)

\)105,000

Given this income statement, compute the following:

d. Break even point in units.

A firm has sales of \(3 million, and 10 percent of the sales are for cash. The year-end accounts receivable balance is \)285,000. What is the average collection period? (Use a 360-day year.)

Lenow鈥檚 Drug Stores and Hall鈥檚 Pharmaceuticals are competitors in the discount drug chain store business. The separate capital structures for Lenow and Hall are presented here:

Lenow

Hall

Debt @ 10%

\(100,000

Debt @ 10%

\)200,000

Common stock, \(10 par

200,000

Common stock, \)10 par

100,000

Total

\(300,000

Total

\)300,000

Shares

20,000

Common shares

10,000

a. Compute earnings per share if earnings before interest and taxes are \(20,000, \)30,000, and $120,000 (assume a 30 percent tax rate).

The Denver Corporation has forecast the following sales for the first seven months of the year:

January

\(15,000

May

\)15,000

February

17,000

June

21,000

March

19,000

July

23,000

April

25,000

Monthly material purchases are set equal to 40 percent of forecast sales for the next month. Of the total material costs, 50 percent are paid in the month of purchase and 50 percent in the following month. Labor costs will run \(4,500 per month, and fixed overhead is \)4,500 per month. Interest payments on the debt will be $3,500 for both March and June. Finally, the Denver salesforce will receive a 3.00 percent commission on total sales for the first six months of the year, to be paid on June 30.

Prepare a monthly summary of cash payments for the six-month period from January through June. (Note: Compute prior December purchases to help get total material payments for January.)
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