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Falcon Financial Group is considering the purchase of Company A or Company B based on a low price-to-book investment strategy that also considers differences in solvency. Selected financial data for both firms, as of December 31, 20X7, follows:

in millions, except per-share data

Company A

Company B

Current assets

$3,000

$5,500


Fixed assets

$5,700

$5,500


Total debt

$2,700

$3,500


Common equity

$6,000

$7,500


Outstanding shares

500

750


Market price per share

$26.00

$22.50


The firms’ financial statement footnotes contain the following:
  • Company A values its inventory using the first in, first out (FIFO) method.
  • Company B’s inventory is based on the last in, first out (LIFO) method. Had Company B used FIFO, its inventory would have been $700 million higher.
  • Company A leases its manufacturing plant. The remaining operating lease payments total $1,600 million. Discounted at 10%, the present value of the remaining payments is $1,000 million.
  • Company B owns its manufacturing plant.

To make the firms financials ratios comparable, calculate the adjusted price-to-book ratios for Company A and Company B.
Company A Company B
A)
$2.17 $2.81
B)
$1.63 $2.06
C)
$2.17 $2.06



Company A should be adjusted for the operating lease liability and the related assets; however, adding the present value of the lease payments to both assets and liabilities does not change equity (book value). Thus, Company A’s adjusted P/B ratio is 2.17 = [$26 price / ($6,000 million equity / $500 million shares)]. Company B’s inventory should be adjusted back to FIFO by adding the LIFO reserve to both assets and equity. Thus, Company B’s P/B ratio is 2.06 = $22.50 / [($7,500 million equity + $700 million LIFO reserve) / 750 million shares].

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At the end of 2007, Decatur Corporation reported last-in, first-out (LIFO) inventory of $20 million, cost of goods sold (COGS) of $64 million, and inventory purchases of $58 million. If the LIFO reserve was $6 million at the end of 2006 and $16 million at the end of 2007, compute first-in, first-out (FIFO) inventory at the end of 2007 and FIFO COGS for the year ended 2007.
FIFO InventoryFIFO COGS
A)
$36 million$54 million
B)
$26 million$54 million
C)
$36 million$74 million



2007 FIFO inventory was $36 million ($20 million LIFO inventory + $16 million reserve). 2007 FIFO COGS was $54 million ($64 million LIFO COGS – $10 million increase in LIFO reserve).

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Patch Grove Nursery uses the LIFO inventory accounting method. Maria Huff, president, wants to determine the financial statement impact of changing to the FIFO accounting method. Selected company information follows:
  • Year-end inventory: $22,000
  • LIFO reserve: $4,000
  • Change in LIFO reserve: $1,000
  • LIFO cost of goods sold: $18,000
  • After-tax income: $2,000
  • Tax rate: 40%

Under FIFO, the nursery’s ending inventory and after-tax profit for the year would have been:
FIFO ending inventoryFIFO after-tax profit
A)
$18,000$2,600
B)
$26,000$2,600
C)
$26,000$1,400



FIFO ending inventory = LIFO ending inventory + LIFO reserve = 22,000 + 4,000 = $26,000
FIFO after-tax profit = LIFO after-tax profit + (change in LIFO reserve)(1 − t) = $2,000 + ($1,000)(1 − 0.4) = $2,000 + $600 = $2,600

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thanks for sharing

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