Solutions Guide: Please do not present as your own.

I sometimes post solutions that

are totally mine, from the book’s solutions manual, or a mix of my work and the
books solutions manual. But this is only meant as a solutions guide for you to answer
the problem on your own. I recommend doing this with any content you buy online
whether from me or from someone else.

P2– Reviewing basic financial statements
1
The income statement for the year ended December 31, 2006, the balance sheets for December 31, 2006 and
2005, and the statement of retained earnings for the year ended December 31, 2006, for Technica, Inc., are 
given on pages 82 and 83 . Briefly discuss the form and informational content of each of these statements.
Technica, Inc. 
Income Statement 
for the Year Ended December 31, 2006

Sales revenue  $600,000

Less: Cost of goods sold  460,000

Gross profits  $140,000

Less: Operating expenses

$30,000 Â
 General and administrative expenses

30,000 Â
 Depreciation expense

 60,000
o Total operating expense

Operating profits  $ 80,000

Less: Interest expense  10,000

Net profits before taxes  $ 70,000

Less: Taxes  27,100

Earnings available for common stockholders  $ 42,900

Earnings per share (EPS) Â $2.15

Technica, Inc. 
 Technica, Inc. 
Income Statement 
for the Year Ended December 31, 2006

Sales revenue  $600,000

Balance Sheets

 December 31

Assets 2006 2005

Cash $ 15,000 $ 16,000

Marketable securities 7,200 8,000

Accounts receivable 34,100 42,200

Inventories 82,000 50,000

 Total current assets $138,300 $116,200

Land and buildings $150,000 $150,000

Machinery and equipment 200,000 190,000

Furniture and fixtures 54,000 50,000

Other 11,000 10,000

 Total gross fixed assets $415,000 $400,000

Less: Accumulated depreciation 145,000 115,000

Net fixed assets $270,000 $285,000

Total assets $408,300 $401,200

Liabilities and Stockholders’ Equity

Accounts payable $ 57,000 $ 49,000

Notes payable 13,000 16,000

Accruals 5,000 6,000

$ 75,000 $ 71,000
 Technica, Inc. 
Income Statement 
for the Year Ended December 31, 2006

Sales revenue  $600,000

 Total current liabilities

Long­term debt $150,000 $160,000

Stockholders’ equity  Â

$110,200 $120,000
 Common stock equity (shares outstanding: 19,500 in 2006 and 
20,000 in 2005)

73,100 50,200
Retained earnings

$183,300 $170,200
o Total stockholders’ equity

Total liabilities and stockholders’ equity $408,300 $401,200

Technica, Inc. 
Statement of Retained Earnings 
for the Year Ended December 31, 2006

Retained earnings balance (January 1, 2006) $50,200

Plus: Net profits after taxes (for 2006) 42,900

Less: Cash dividends (paid during 2006) 20,000

Retained earnings balance (December 31,  $73,100
2006)

Income statement: In this one-year summary of the firm’s operations,

Technica, Inc. showed a net profit for 2006 and the ability to pay cash
dividends to its stockholders.
Balance sheet: The financial condition of Technica, Inc. at December 31, 2005
and 2006 is shown as a summary of assets and liabilities. Technica, Inc. has
an excess of current assets over current liabilities, demonstrating liquidity.
 The firm’s fixed assets represent over one-half of total assets ($270,000 of
$408,300). The firm is financed by short-term debt, long-term debt, common
stock, and retained earnings. It appears that it repurchased 500 shares of
common stock in 2006.
Statement of retained earnings: Technica, Inc. earned a net profit of $42,900
in 2006 and paid out $20,000 in cash dividends. The reconciliation of the
retained earnings account from $50,200 to $73,100 shows the net amount
($22,900) retained by the firm.

P2– Financial statement account identification
2
Mark each of the accounts listed in the following table as follows:

a. In column (1), indicate in which statement—income statement (IS) or balance sheet (BS)—the 
account belongs.
b. In column (2), indicate whether the account is a current asset (CA), current liability (CL), expense 
(E), fixed asset (FA), long­term debt (LTD), revenue (R), or stockholders’ equity (SE).
(1)  (2) 
Account name Statement Type of account

Accounts payable _______ _______

Accounts receivable _______ _______

Accruals _______ _______

Accumulated depreciation _______ _______

Administrative expense _______ _______

Buildings _______ _______

Cash _______ _______

Common stock (at par) _______ _______

Cost of goods sold _______ _______

Depreciation _______ _______

Equipment _______ _______

General expense _______ _______

 (1)  (2) 
Account name Statement Type of account

Interest expense _______ _______

Inventories _______ _______

Land _______ _______

Long­term debts _______ _______

Machinery _______ _______

Marketable securities _______ _______

Notes payable _______ _______

Operating expense _______ _______

Paid­in capital in excess of  _______ _______

par

Preferred stock _______ _______

Preferred stock dividends _______ _______

Retained earnings _______ _______

Sales revenue _______ _______

Selling expense _______ _______

Taxes _______ _______

Vehicles _______ _______

 (a) (b)
Account Name Statement Type of Account
Accounts payable BS CL
Accounts receivable BS CA
Accruals BS CL
Accumulated depreciation BS FA*
Administrative expense IS E
Buildings BS FA
Cash BS CA
Common stock (at par) BS SE
Cost of goods sold IS E
Depreciation IS E
Equipment BS FA
General expense IS E
Interest expense IS E
Inventories BS CA
Land BS FA
Long­term debt BS LTD
Machinery BS FA
Marketable securities BS CA
Notes payable BS CL
Operating expense IS E
Paid­in capital in excess of par BS SE
Preferred stock BS SE
Preferred stock dividends IS E
Retained earnings BS SE
Sales revenue IS R
Selling expense IS E
Taxes IS E
Vehicles BS FA

* Here we have to remember that Accumulated Depreciation is actually a “Contra Asset

Account”

P4– Funding your retirement
23
You plan to retire in exactly 20 years. Your goal is to create a fund that will allow you to receive $20,000 
at the end of each year for the 30 years between retirement and death (a psychic told you would die exactly 
30 years after you retire). You know that you will be able to earn 11% per year during the 30­year 
retirement period.

1. How large a fund will you need when you retire in 20 years to provide the 30­year, $20,000 
retirement annuity?
 2. How much will you need today as a single amount to provide the fund calculated in part a if you earn 
only 9% per year during the 20 years preceding retirement?
3. What effect would an increase in the rate you can earn both during and prior to retirement have on the
values found in parts a and b? Explain.

(a) PVA  PMT(PVIFA11%,30) (b) PV  FV(PVIF9%,20)

PVA  $20,000(8.694) PV  $173,880  (0.178)
PVA  $173,880.00 PV  $30,950.64
Calculator solution: $173,875.85 Calculator solution: $31,024.82

(c) Both values would be lower. In other words, a smaller sum would be needed in 
20 years for the annuity and a smaller amount would have to be put away today 
to accumulate the needed future sum.

P4– Funding budget shortfalls
32
As part of your personal budgeting process, you have determined that in each of the next 5 years you will 
have budget shortfalls. In other words, you will need the amounts shown in the following table at the end of
the given year to balance your budget—that is, to make inflows equal outflows. You expect to be able to 
earn 8% on your investments during the next 5 years and wish to fund the budget shortfalls over the next 5 
years with a single amount.

End of  Budget shortfall
year

1 $ 5,000

2 4,000

3 6,000

4 10,000

5 3,000

a. How large must the single deposit today into an account paying 8% annual interest be to 
provide for full coverage of the anticipated budget shortfalls?

b. What effect would an increase in your earnings rate have on the amount calculated in 
part a? Explain.
 (a)
Budget
Year Shortfall  PVIF8%,n  Present Value
1 $5,000  0.926  $4,630
2 4,000  0.857  3,428
3 6,000  0.794  4,764
4 10,000  0.735  7,350
5 3,000  0.681  2,043
$22,215
Calculator solution: $22,214.03

A deposit of $22,215 would be needed to fund the shortfall for the pattern shown in the table.
(b) An increase in the earnings rate would reduce the amount calculated in part (a). The higher 
rate would lead to a larger interest being earned each year on the investment. The larger 
interest amounts will permit a decrease in the initial investment to obtain the same future 
value available for covering the shortfall.

P4– Loan amortization schedule
46
Joan Messineo borrowed $15,000 at a 14% annual rate of interest to be repaid over 3 years. The loan is 
amortized into three equal, annual, end­of­year payments.

1. Calculate the annual, end­of­year loan payment.
2. Prepare a loan amortization schedule showing the interest and principal breakdown of each of the 
three loan payments.
3. Explain why the interest portion of each payment declines with the passage of time.
 (a) PMT  $15,000  (PVIFA14%,3)
PMT  $15,000  2.322
PMT  $6,459.95
Calculator solution: $6,460.97
(b)

End of Loan Beginning of Payments End of Year

Year Payment Year Principal Interest Principal Principal

1 $6,459.95 $15,000.00 $2,100.00 $4,359.95 $10,640.05

2 $6,459.95 10,640.05 1,489.61 4,970.34 5,669.71
3 $6,459.95 5,669.71 793.76 5,666.19 0

(The difference in the last year’s beginning and ending principal is due to rounding.)
(c) Through annual end­of­the­year payments, the principal balance of the loan is declining, 
causing less interest to be accrued on the balance.

P4– Monthly loan payments
48
Tim Smith is shopping for a used car. He has found one priced at $4,500. The dealer has told Tim that if he
can come up with a down payment of $500, the dealer will finance the balance of the price at a 12% annual
rate over 2 years (24 months).

a. Assuming that Tim accepts the dealer’s offer, what will his monthly (end­of­month) payment 
amount be?
b. Use a financial calculator or Equation 4.15a (found in footnote 9) to help you figure out what 
Tim’s monthly payment would be if the dealer were willing to finance the balance of the car price at a 
9% annual rate.

(a) PMT  $4,000  (PVIFA1%,24)
PMT  $4,000  (21.243)
PMT  $188.28
Calculator solution: $188.29
(b) PMT  $4,000  (PVIFA0.75%,24)
PMT  $4,000  (21.889)
PMT  $182.74
Calculator solution: $182.74

P6– Basic bond valuation
15
Complex Systems has an outstanding issue of $1,000­par­value bonds with a 12% coupon interest rate. 
The issue pays interest annually and has 16 years remaining to its maturity date.

A. If bonds of similar risk are currently earning a 10% rate of return, how much should the Complex 
Systems bond sell for today?
B. Describe the two possible reasons why similar­risk bonds are currently earning a return below the 
coupon interest rate on the Complex Systems bond.
C. If the required return were at 12% instead of 10%, what would the current value of Complex 
Systems’ bond be? Contrast this finding with your findings in part a and discuss.

(a) Bo  I  (PVIFAkd%,n)  M  (PVIFkd%,n)
Bo  120  (PVIFA10%,16)  M  (PVIF10%,16)
Bo  $120  (7.824)  $1,000  (0.218)
Bo  $938.88  $218
Bo  $1,156.88
Calculator solution: $1,156.47
(b) Since Complex Systems’ bonds were issued, there may have been a shift in the supply­demand 
relationship for money or a change in the risk of the firm.
(c) Bo  I  (PVIFAkd%,n)  M  (PVIFkd%,n)
Bo  120  (PVIFA12%,16)  M  (PVIF12%,16)
Bo  $120  (6.974)  $1,000  (0.163)
Bo  $836.88  $163
Bo  $999.88
Calculator solution: $1,000
When the required return is equal to the coupon rate, the bond value is equal to the par value. In 
contrast to (a) above, if the required return is less than the coupon rate, the bond will sell at a 
premium (its value will be greater than par).

P7– Common stock valuation—Zero growth
6
Scotto Manufacturing is a mature firm in the machine tool component industry. The firm’s most recent 
common stock dividend was $2.40 per share. Because of its maturity as well as its stable sales and earnings,
the firm’s management feels that dividends will remain at the current level for the foreseeable future.

a. If the required return is 12%, what will be the value of Scotto’s common stock?
b. If the firm’s risk as perceived by market participants suddenly increases, causing the required return to
rise to 20%, what will be the common stock value?
c. Judging on the basis of your findings in parts a and b, what impact does risk have on value? Explain.
(a) Po $2.40  0.12
Po $20
(b) Po $2.40  0.20
Po $12
(c) As perceived risk increases, the required rate of return also increases, causing the stock price
to fall.