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hsa 525 weeek 5 372 EXAMPLES AND EXERCISES, SUPPLEMENTAL MATERIALS, AND SOLUTIONS CHAPTER 10 Practice Exercise 10-1: Components of Balance Sheet and Statement of Net Income Financial statements for Doctors Smith and Brown are provided below. Use the doctors' balance sheet, statement of revenue and expenses, and statement of capital for this assignment. Required Identify the following doctors' balance sheet and statement of net income components. List the name of each component and its amount(s) from the appropriate financial statement. Current Liabilities Total Assets Income from Operations Accumulated Depreciation Total Operating Revenue Current Portion of Long-Term Debt Interest Income Inventories ~signment Exercise 10-1: Components of Balance Sheet and Statement of Net Income Refer to the Metropolis Health System (MHS) supplemental information at the back ofthe Examples and Exercises section. Use the MHS comparative balance sheet, statement of revenue and expenses, and statement of fund balance for this assignment. Required Identify the following MHS balance sheet components. List the name of each component and its amount(s) from the appropriate MHS financial statement. Current Liabilities Total Assets Income from Operations Accumulated Depreciation Total Operating Revenue Current Portion of Long-Term Debt Interest Income Inventories Chapter10 375 The MIlS Balance Sheet Example lOA:Components of Balance Sheet and Income Statement The "Accounts Receivable (net)" in Exhibit 10-1 means the accounts receivable figure of $250,000 on the balance sheet is net of the allowance for bad debts. If the allowance for bad debts is raised on the balance sheet, then bad debt expense (a.k.a provision for doubtful accounts) on the income statement (a.k.a. statement of revenue and expense) also rises. Think of these two accounts as a pair. Practice Exercise 10-11: Components of Balance Sheet and Income Statement Refer to Doctors Smith and Brown's balance sheet, where patient accounts receivable is stated at $40,000. Do you think this figure is net of an allowance for bad debts? *Assignment Exercise 10-2: Components of Balance Sheet and Income Statement Refer to the Metropolis Health System (MHS) balance sheet and statement of revenue and expense in Chapter 25's MHS Case Study. Patient accounts receivable of $7,400,000 is shown as net of $1,300,000 allowance for bad debts (8,700,000 - 1,300,000 = 7,400,000). (a) What percent of gross accounts receivable is the allowance for bad debts? (b) If the allowance for bad debts is raised to $1,500,000, where does the extra $200,000 go? Example lOB: Components of Balance Sheet and Income Statement Refer to Exhibit 10-1 and Exhibit 10-2's Westside Clinic statements. The "Property, Plant, and Equipment (net)" total in Exhibit 10-1means the property, plant, and equipment figure of $360,000 on the balance sheet is net of the reserve for depreciation. If the reserve for depreciation is raised on the balance sheet, then the depreciation expense on the income statement (a.k.a, statement of revenue and expense) also rises. Think of these two accounts as another pair. Practice Exercise 10-ID: Components of Balance Sheet and Income Statement Refer to Doctors Smith and Brown's balance sheet, where buildings and equipment are both stated as net (the $820,000 figure), but land is not. Do you recall why this is so? -¥Assignment Exercise 10-3: Components of Balance Sheet and Income Statement Refer to the Metropolis Health System (MHS) balance sheet and statement of revenue and expense in Chapter 25's MHS Case Study. Property, plant, and equipment of$19,300,000 is shown as "net," meaning net of the reserve for depreciation. If the $19,300,000 is reduced by $200,000 (meaning the reserve for depreciation has risen), what happens on the income statement? 376 EXAMPLES AND EXERf:ISES, SUPPLEMENTAL MATERIALS, AND SOLUTIONS CHAPTER 11 Example llA To better understand how the information for the numerator and the denominator of each calculation is obtained, Figure 11-1, "Examples of Liquidity Ratio Calculations," illustrates the process. This figure takes the balance sheet and the statement of revenue and expense that were discussed in the preceding chapter and illustrates the source of each figure in the four liquidity ratios. The multiple computations in days cash on hand and in days receivables are further broken out into a three-step process to better illustrate sources of information. Practice Exercise 11-1: Liquidity Ratios Two of the liquidity ratios are illustrated in this practice exercise. Refer to Doctors Smith and Brown's financial statements presented in the preceding Chapter 10. Required 1. Set up a worksheet for the current ratio and the quick ratio. 2. Compute the ratios for Doctors Smith and Brown. *'Assignment Exercise 11-1: Liquidity Ratios Refer to the Metropolis Health System (MHS) case study in Chapter 25. Required 1. Set up a worksheet for the liquidity ratios. 2. Compute the four liquidity ratios using the Chapter 25 MHS financial statements. Example lIB To better understand how the information for the numerator and the denominator of each calculation is obtained, Figure 11-2, "Examples of Solvency and Profitability Ratio Calculations," illustrates the process. This figure takes the balance sheet and the statement of revenue and expense that were discussed in the preceding chapter and illustrates the source of each figure in the two solvency ratios. Any multiple computations are further broken out to better explain sources of information. Practice Exercise II-II: Solvency Ratios Refer to Doctors Smith and Brown's financial statements presented in the preceding Chapter 10. Required 1. Set up a worksheet for the solvency ratios. Chapter 11 377 2. Compute these ratios for Doctors Smith and Brown. To do so, you will need one additional piece of information that is not present on the doctors' statements: their maximum annual debt service is $22,200. ~signment Exercise 11-2: Solvency Ratios Refer to the Metropolis Health System (MHS) case study in Chapter 25. Required 1. Set up a worksheet for the liquidity ratios. 2. Compute the solvency ratios using the Chapter 25 MHS financial statements. Example 11C To better understand how the information for the numerator and the denominator of each calculation is obtained, study Figure 11-2, "Examples of Solvency and Profitability Ratio Calculations." This figure takes the balance sheet and the statement of revenue and expense that were discussed in the preceding chapter and illustrates the source of each figure in the two profitability ratios. Any multiple computations are further broken out to better explain sources of information. Practice Exercise II-III: Profitability Ratios Refer to Doctors Smith and Brown's financial statements presented in the preceding Chapter 10. Required 1. Set up a worksheet for the profitability ratios. 2. Compute these ratios for Doctors Smith and Brown. All the necessary information is present on the doctors' statements. [Hint: "Operating Income (Loss)" is also known as "Income from Operations."] ~signment Exercise 11-3: Profitability Ratios Refer to the Metropolis Health System (MHS) case study in Chapter 25. Required l. Set up a worksheet for the liquidity ratios. 2. Compute the profitability ratios using the Chapter 25 MHS financial statements. 378 EXAMPLES AND EXERCISES, SUPPLEMENTAL :MATERIALS, AI,!}) SOLUTIONS CHAPTER 12 Example 12A: Unadjusted Rate of Return Assumptions: • Average annual net income = $100,000 • Original investment amount = $1,000,000 • Unrecovered asset cost at the end of useful life (salvage value) = $100,000 Calculation using original investment amount: $100,000 = 10% Unadjusted Rate of Return $1,000,000 Calculation using average investment amount: First Step: Compute average investment amount for total unrecovered asset cost. At beginning of estimated useful life = At end of estimated useful life $1,000,000 $ 100,000 Sum $1,100,000 Divided by 2 = $550,000 average investment amount Second Step: Calculate unadjusted rate of return. $100,000 __ --'0_ = 18.2% Unadjusted Rate of Return $550,000 Practice Exercise 12-1: Unadjusted Rate of Return Assumptions: • Average annual net income = $100,000 • Original investment amount = $500,000 • Unrecovered asset cost at the end of useful life (salvage value) = $50,000 Required 1. Compute the unadjusted rate of return using the original investment amount. 2. Compute the unadjusted rate of return using the average investment method. *Assignment Exercise 12-1: Unadjusted Rate of Return Metropolis Health Systems' Laboratory Director expects to purchase a new piece of equipment. The assumptions for the transaction are as follows: • Average annual net income = $70,000 • Original investment amount = $410,000 • Unrecovered asset cost atthe end of usefullife (salvage value) = $41,000 Chapter 12 379 Required 1. Compute the unadjusted rate of return using the original investment amount. 2. Compute the unadjusted rate of return using the average investment method. Example 12B: Finding the Future Value (with a Compound Interest Table) BettyDylan is Director of Nurses at Metropolis Health System.Her oldest son willbe entering college in fiveyears. Today Betty is trying to figure what his college fund willamount to in fivemore years. (Hint: Compound interest means interest is not only earned on the principal, but also is earned on the previous interest earnings that have been left in the account. Interest is thus compounded.) The college fund savings account presently has a balance of $9,000 and any interest earned over the next fiveyears willbe left in the account. Betty assumes the annual interest rate willbe 6 percent. How much money willbe in the account at the end offive more years? Solution to Example Step 1. Refer to the Compound Interest Table found in Appendix 12-Bat the back of this chapter. Reading across, or horizontally, find the 6% column. Reading down, or vertically, find Year 5. Trace across the Year 5 line item to the 6% column. The factor is 1.338. Step 2. Multiply the current savings account balance of$9,000 times the factor of 1.338 to find the future value of $12,042. In fiveyears at compound interest of 6% the college fund will have a balance of$12,042. Practice Exercise 12-11: Finding the Future Value (with a Compound Interest Table) Assume the college savings fund in the preceding example presently has a balance of $11,000 and any interest earned willbe left in the account. Assume the annual interest rate willbe 7%. Required Compute how much money willbe in the account at the end of sixmore years. (Use the Future Value or Compound Interest Table found at the back of this chapter.) _~signment Exercise 12-2: Finding the Future Value .r (with a Compound Interest Table) John Whitten is one of the physicians on staff at Metropolis Health System. His practice is six years old. He has set up an office savings account to accumulate the funds to replace equipment in his practice. Today John is trying to figure what his equipment fund will amount to in four more years. The equipment fund savingsaccount presently has a balance of $63,500 and any interest earned over the next four years willbe left in the account. John assumes the annual interest rate willbe 5 percent. How much money willbe in the account at the end of four more years? 380 EXAMPLES Al"JDEXERCISES, SUPPLEMENTAL MATERIALS, Al"JDSOLUTIONS Required Compute how much money will be in the account at the end of four more years. (Use the Future Value or Compound Interest Table found at the back of this chapter.) Example 12C:Finding the Present Value (with a Present Value Table) Betty Dylan is taking an adult education night course in personal finance at the community college. The class is presently studying retirement planning. Each student is to estimate the amount of funds (in addition to pension plans and social security) they believe will be needed at retirement. Then they are to make a retirement plan. Betty has estimated she would need $100,000 fifteen years from now. In order to complete her assignment she needs to know the present value of the $100,000. Bettyfurther assumes an interest rate of 6 percent. Solution to Example Step 1. Refer to the Present Value Table found in Appendix 12-Aat the back of this chapter. Reading across, or horizontally, find the 6% column. Reading down, or vertically,find Year 15.Trace across the Year 15line item to the 6% column. The factor is 0.4173. Step 2. Multiply $100,000 times the factor of0.4173 to find the present value of$41,730. Practice Exercise 12-ill: Finding the Present Value (with a Present Value Table) Bettyisn't finished with her assignment. Nowshe wants to find the present value of$150,000 accumulated fifteen years from now. She further assumes a better interest rate of 7 percent. Required Compute the present value of$150,000 accumulated fifteen years from now.Assume an interest rate of7 percent. (Use the Present Value Table found at the back of this chapter.) ;\::.Assignment Exercise 12-3: Finding the Present Value (with a Present Value Table) Part I-Dr. John Whitten is still figuring out his equipment fund. According to his calculations he needs $250,000 to be accumulated six years from now.John is now trying to find the present value of the $250,000. He continues to assume an interest rate of 5 percent. Required Compute the present value of $250,000 accumulated fifteen years from now.Assume an interest rate of 5 percent. (Use the Present Value Table found at the back of this chapter.) Part 2-John doesn't like the answer he gets. What if he can raise the interest rate to 7 percent? How much difference would that make? Chapter 12 381 Example 12D: Internal Rate of Return Reviewthe chapter text to follow the steps set out to compute the internal rate of return. Practice Exercise 12-IV: Internal Rate of Return Metropolis Health System (MHS) is considering purchasing a tractor to mow the grounds. It would cost $16,950 and have a 10-yearuseful life. It will have zero salvagevalue at the end of 1°years. The head of the MHS grounds crew estimates it would save $3,000 per year. He figures this savingsbecause just one of the present maintenance crew would be driving the tractor, replacing the labor of several men now using small household-type lawn mowers. Compute the internal rate of return for this proposed acquisition. ~~signment Exercise 12-4: Computing an Internal Rate of Return Dr.Whitten has decided to purchase equipment that has a cost of$60,000 and will produce a pretax net cash inflow of $30,000 per year over its estimated useful life of six years. The equipment will have no salvage value and will be depreciated by the straight-line method. The tax rate is 50%. Determine Dr. Whitten's approximate after-tax internal rate of return. Example 12E: Payback Period Reviewthe chapter text and follow the Doctor Green detailed example of payback period computation. Practice Exercise 12-V: Payback The MHS Chief Financial Officer is considering a request by the Emergency Room department for purchase of new equipment. It will cost $500,000. There is no trade-in. Its useful life would be 10years. This type of machine isnew to the department but it is estimated that it will result in $84,000 annual revenue and operating costs would be one quarter of that amount. The CFO wants to find the payback period for this piece of equipment. ~signment Exercise 12-5: Payback Period The MHS Chief Financial Officer is considering alternate proposals for the hospital Radiology department. The Director of Radiology has suggested purchasing one of two pieces of equipment. Machine A costs $15,000 and Machine B costs $12,000. B~chines are estimated to reduce radiology operating costs by $5,000 per year. Lc-o'lt+' 382 EXAt'vlPLES AND EXERCISES, SUPPLEMENTAL lVl.<\TERIALS,AND SOLUTIONS Required Which machine should be purchased? Make your payback calculations to provide the answer. --------------------------------------------------------------------------------~ CHAPTER 13 Example 13A: Common Sizing Common sizing converts numbers to percentages so that comparative analysis can be performed. Reread the chapter text about common sizing and examine the percentages shown in Table 13-1. Practice Exercise 13-1: Common Sizing Current Assets Property, Plant, & Equipment Other Assets Total Assets The worksheet below shows the assets of two hospitals. Required Perform common sizing for the assets of the two hospitals. Same Yearfor Both Hospitals Hospital A Hospital B $ 2,000,000 $ 8,000,000 7,500,000 30,000,000 500,000 2,000,000 $10,000,000 $40,000,000 Assignment Exercise 13-1: Common Sizing Refer to the Metropolis Health System (MHS) comparative financial statements at the back of the Examples and Exercises section. Required Common size the MHS statement of revenue and expenses. Example 13B: Trend Analysis Trend analysis allows comparison of figures over time. Reread the chapter text about trend analysis and examine the difference columns shown in Table 13-3. Practice Exercise I3-II: Trend Analysis The worksheet below shows the assets of Hospital A over twoyears. Required Perform trend analysis for the assets of Hospital A. -------------~- - -