Question

Using the money from their recent bond issue, Terry’s management has decided to declare an additional $562,500 dividend. The date of declaration is December 30, Year 3. The date of record will be January 15, Year 4, and the date of payment will be January 30, Year 4.

As an additional signal to the market, Terry’s management repurchased 205,000 shares of Terry’s common stock on December 15, Year 3 for $8.00 a share.

Terry’s management would like to know the effect of the sale on the following ratios:

• Current Ratio

• ROA

1. What do you think Terry’s creditors’ (i.e. bank and bond holder) reaction will be to management’s decision to issue a second dividend and to repurchase shares? In other words, based on your changes to the financial statements and the change in the ratios, do you think the creditors will be happy with the decision to pay out so much cash to investors? Why or why not?

2. At the beginning of Year 2, Terry’s Board of Directors authorized stock options for the executive team. The team could buy shares from the company at a set price for $10.00/share, then sell them at the current market price to make a bonus. On December 10th, Terry’s stock price was only $8.40/share, making these stock options worthless. Based on this information, do you think that the management teams’ decision to authorize an additional dividend and repurchase shares on December 15th was ethical? Why or why not?

Terry Co. Multi-Step Income Statement For the Year Ended December 31, Year 3 Sales Revenue Less: Sales Discounts $66,600,000 $666,000 Sales Returns $5,827,500 $6,493,500 $60,106,500 Net Sales Revenue Cost of Goods Sold $36,534,013 $23,572,487 Gross Profit erating Activities Selling Expenses Advertising Expense Bad Debt Expense Miscellaneous Selling Expenses Sales Force Salaries Expense Selling Commissions Expense Shipping Expense $1,248,750 $566,100 $324,675 $915,750 $3,330,000 $545.288 Total Selling Expenses Administrative Expenses 6,930,563 Executive Salaries Expense Depreciation & Amortization Expense$1,998,000 Insurance Expense Miscellaneous Admin. Expenses Office Supplies Expense R&D Expense Utilities Expense $2,913,750 $241,425 $32,884 $258,075 $999,000 $499,500 Total Administrative Expenses Income from Operations $6,942,634 $13,873,197 $9,699,290 er Gains an Rent Revenue Interest Expense $208,125 57,054) ($248,929) $9,450,361 ($2,362,590 $7,087,771 Income from Continuing Operations before Taxes Income Tax Expense Net Income EPS 2.66

Answer 1

Solution:

Current Ratio

= Current Assets / Current Liabilities

= 20539969 / 7595250

= 2.70

Return on Assets

= Net Income / Total Assets

= 7087771 / 49690579

= 0.143

Particulars	Debit	Credit
At the time of dividend declaration: Retaind Earnings A/C.............Dr To Dividend Payable A/C	562500	562500
At the time of repurchase Common Stock A/C.............Dr Additional Capital A/...........Dr To Cash / Bank A/C	205000 1435000	1640000

All other items of financial statements remain unchanged. However, following are the exceptions:

• Retained earnings reduced to $23071303 (23633803-562500)
• Dividend payable will be added under the head current liabilities with $562500
• Common stock reduced to $2455000 (2660000-205000)
• Additional paid in capital reduced to  $563000 (1998000-143500)
• Cash balance reduced to $3914969 (5554969-1640000)