You\'ve been asked to tutor Josh, a finance student who doesn\'t feel comfortabl

Question

You've been asked to tutor Josh, a finance student who doesn't feel comfortable about his understanding of the relationship between a company's business activities, its financial accounts, and the company's financial ratios. To better appreciate these relationships, you've created the following exercises for Josh to complete. The purpose of these exercises is to help Josh (1) understand the effect of business transactions on financial statement-such as balance sheet and income statement-accounts and (2) how these changes in the numerators and denominators of financial ratios affect the ratios values. However, before using these exercises in your tutoring session later today, you'll want to run the calculations on the following two business transactions, to verify the accuracy of your answers To provide a consistent frame of reference for the company's financial statements and ratios, assume that the following balance sheet and income statement reflect the company's pretransaction condition and performance National Transmissions Inc.'s Statement of Financial Condition Statement of Financial Performance $20,000 20,000 10,000 50,000 Cash $15,000 Accounts payable $5,000,000 2,000,000 3,000,000 600,000 2,400,000 33,000 2,367,000 10,000 Wages payable 70,000 Taxes payable 500,000 Notes payable Less: Cost of goods sold Gross profit Accounts receivable 5,000 00,000 Less: Operating expenses Prepaid expenses Total current liabilities 500,000 Operating profit (EBIT Total current assets ,000,000 Long-term debt Less: Interest expense Earnings before taxes (EBT Less: Tax expense Net income Total liabilities 600,000 150,000 350,000 00,000 1,400,000 2,000,000 Gross plant and equipment 1,500,000 Common stock 500,000 Capital paid in excess of par ,000,000 Retained earnings Net plant and equipment 1,538,55 Total equity Total debt and equity Total assets $2,000,000 Cost of goods sold equals 40% of sales. 2|nterest expense equals 6% of the combined notes payable and long-term debt balances he average federal and state tax rate is 35%.

Explanation / Answer

Transaction 1:

The company sells 25000 new shares to the shareholder at the rate of $20 per share.

Therefore the total number of shares will be increased by 25000 and the shareholder's fund or networth will be increased by = 25000 * 20 = $ 5,00,000

There will be no change in income statement but increase the balance sheet since the amount increased by issuing new shares will increase the networth of the company.

Transaction 2:

A $500000 10 year bank loan will increase the debt of the company, therefore company has to bear interest exp. Therefore, the netincome will be reduced and the balance sheet will be increased

Retained earnings no change Long term debt no change Operating income no change capital paid in excee of par increased by 500000 cash increased by 500000 common stock increased by 25000

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