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Consider the following thoughts of a manager at the end of the company’s third quarter:
If I can increase my reported profit by $2 million, the actual earnings per share will exceed analysts’ expectations, and stock prices will increase. The stock options that I am holding will become more valuable. The extra income will also make me eligible to receive a significant bonus. With a son headed to college, it would be good if I could cash in some of these options to help pay his expenses. However, my vice president of finance indicates that such an increase is unlikely. The projected profit for the fourth quarter will just about meet the expected earnings per share. There may be ways, though, that I can achieve the desired outcome. First, I can instruct all divisional managers that their preventive maintenance budgets are reduced by 25 percent for the fourth quarter. That should reduce maintenance expenses by approximately $1 million. Second, I can increase the estimated life of the existing equipment, producing a reduction of
Required:
Comment on the ethical content of the earnings management being considered by the manager. Is there an ethical dilemma? What is the right choice for the manager to make? Is there any way to redesign the accounting reporting system to discourage the type of behavior the manager is contemplating?
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Chapter 1 Solutions
Cornerstones of Cost Management (Cornerstones Series)
- You have invested in a business that proudly reports that it is profitable. Your investment of $4800 has produced a profit of $298. The managers think that if you leave your $4800 invested with them, they should be able to generate S298 per year in profits for you in perpetuity. Evaluating other investment opportunities, you note that other long-term investments of similar risk offer an expected return of 8%. Should you remain invested in this firm? The expected return of your investment is %. (Round to one decimal place.)arrow_forwardSuppose that you are in the fall of your senior year and are faced with the choice of either getting a job when you graduate or going to law school. Of course, your choice is not purely financial. However, to make an informed decision you would like to know the financial implications of the two alternatives. Let's assume that your alternatives are as follows: If you take the "get a job" route you expect to start off with a salary of $35,000 per year. There is no way to predict what will happen in the future, your best guess is that your salary will grow at 4 percent per year until you retire in 44 years. As a law student, you will be paying $30,000 per year tuition for each of the 3 years you are in graduate school. However, you can then expect a job with a starting salary of $75,000 per year. Moreover, you expect your salary to grow by 8 percent per year until you retire 38 years later. Clearly, your total expected lifetime salary will be higher if you become a…arrow_forwardKaren Lamont is in the process of starting a new business and wants to forecast the first year's income statement and balance sheet. She has made several assumptions, which are shown below: Lamont has projected the firm's sales will be $1 million in the first year. She believes that the operating and gross profit margins will be 20 percent and 50 percent, respectively. For working capital, Lamont has estimated the following: Accounts receivable as a percentage of sales: 12% Inventory as a percentage of sales: 15% Accounts payable as a percentage of sales: 7% Accruals as a percentage of sales: 5% A bank has agreed to loan her $300,000, consisting of $100,000 in short-term debt and $200,000 in long-term debt. Both loans will have an 8 percent interest rate. The firm's tax rate will be 30 percent. Lamont will need to purchase $350,000 in plant and equipment. Lamont will provide any other financing needed.Based on Lamont's assumptions in Situation 3, prepare a pro forma income…arrow_forward
- You have invested in a business that proudly reports that it is profitable. Your investment of $4000 has produced a profit of $201. The managers think that if you leave your $4500 levested with them, they should be able to generate $291 per year in profits for you in perpetuity. Evaluating other investment opportunites, you note that other long-term investments of similar risk offer an expected return of 7.9%. Should you remain invested in this fr ? The expected ratus of your envestment is__? (Round to one decimal)arrow_forwardSuppose that you are in the fall of your senior year and are faced with the choice of either getting a job when you graduate or going to law school. Of course, your choice is not purely financial. However, to make an informed decision you would like to know the financial implications of the two alternatives. Let's assume that your alternatives are as follows: If you take the "get a job" route you expect to start off with a salary of $40,000 per year. There is no way to predict what will happen in the future, your best guess is that your salary will grow at 5 percent per year until you retire in 45 years. As a law student, you will be paying $25,000 per year tuition for each of the 3 years you are in graduate school. However, you can then expect a job with a starting salary of $75,000 per year. Moreover, you expect your salary to grow by 7 percent per year until you retire 39 years later. Clearly, your total expected lifetime salary will be higher if you become a…arrow_forwarduppose that you are in the fall of your senior year and are faced with the choice of either getting a job when you graduate or going to law school. Of course, your choice is not purely financial. However, to make an informed decision you would like to know the financial implications of the two alternatives. Let's assume that your alternatives are as follows: If you take the "get a job" route you expect to start off with a salary of $45,000 per year. There is no way to predict what will happen in the future, your best guess is that your salary will grow at 5 percent per year until you retire in 43 years. As a law student, you will be paying $20,000 per year tuition for each of the 3 years you are in graduate school. However, you can then expect a job with a starting salary of $75,000 per year. Moreover, you expect your salary to grow by 8 percent per year until you retire 36 years later. Clearly, your total expected lifetime salary will be higher if you become a…arrow_forward
- Use your own words to answer the following questions: Write the formula for the P/E ratio and what it measures? Should you invest in a company with high P/E or low P/E? A company has the following items for the fiscal year 2020: Revenue = 10 million Net income = 4 million The company has 2 million shares of stock Stock price per share = $70 Calculate the company’s earnings per share and P/E ratioarrow_forwardKerrigan Corporation announced on November 1, 2021 that company's CEO has been terminated and that James McCabe will become the company's new CEO. Kerrigan has had decreasing income over the last several of years. McCabe will be responsible for improving Kerrigan's future performance. What earnings management technique will the company probably utilize as a result of hiring a new CEO? Question 30 options: a) Increase cookie jar reserves b) Big Bath c) Accelerate current period revenues into future periods d) Accelerating future period expenses into the current periodarrow_forwardAaron Heath is seeking part-time employment while he attends school. He is considering purchasing technical equipment that will enable him to start a small training services company that will offer tutorial services over the Internet. Aaron expects demand for the service to grow rapidly in the first two years of operation as customers learn about the availability of the Internet assistance. Thereafter, he expects demand to stabilize. The following table presents the expected cash flows: In addition to these cash flows, Aaron expects to pay $20,100 for the equipment. He also expects to pay $3,500 for a major overhaul and updating of the equipment at the end of the second year of operation. The equipment is expected to have a $1,800 salvage value and a four year useful life. Aaron desires to earn a rate of return of 8 percent. (PV of $1 and PVA of $1) (Use appropriate factor(s) from the tables provided.)arrow_forward
- The financial manager for "ERR" industrial Company would extend the credit terms from "net 30" to "net 45" in order to stimulate credit sales. 'ERR' Company also benefits from relaxing of terms from its suppliers from "net 30" to "net 35". The manager is wondering how to estimate the financial impact of these alternatives would have on the shareholder's wealth. The financial manager estimates that the daily sales increase at a growth rate equals 10% following the extension of DSO. You gathered the following information:Purchase amount = 40% of sales amount Annual sales amount = $31,025,000 The annual cost of capital = 10% Inventory turnover =18.25 1- Calculate the daily NPV of the current terms. 2- Calculate the daily NPV of the proposed terms. 3- Based on your own calculations, what is your recommendation? Why? 4- Calculate the NPVCCP of the present terms. Interpret. 5- Calculate the ANPVCCP-aggregate of the Company. Interpret.arrow_forwardAs an analyst for Kingbird Inc., you are responsible for many firms, including ADFC. Currently you have a "hold" recommendation on ADFC. The current price of ADFC is $154. You have conducted an extensive analysis of the industry and you feel that the probability the firm will capture a substantial share of the new market is 25 percent. If the firm is able to capture the new market, you are expecting earnings to grow at a rate of 45 percent per year for the next five years. In that case, the stock price would rise to $234 due to the unusually high growth rate of future earnings. However, you feel there is a 35-percent probability that the firm will face serious difficulties in the near future, in which case the stock price will fall to $114, and the earnings growth rate will drop to 3 percent. There is a 40-percent chance that nothing will change for the firm and its earnings growth rate will remain at 12 percent. Calculate the expected price in the future. (Round intermediate…arrow_forwardAs part of their investment strategy, the Carringtons have decided to put $100,000 into stock market investments and also into purchasing precious metals. The performance of the investments depends on the state of the economy in the next year. In an expanding economy, it is expected that their stock market investment will outperform their investment in precious metals, whereas an economic recession will have precisely the opposite effect. Suppose the following payoff matrix gives the expected percentage increase or decrease in the value of each investment for each state of the economy. Stock market investment Commodity investment Expanding Economic economy recession -10t 10 commodities 15 5 (a) Determine the optimal investment strategy for the Carringtons' investment of $100,000. (Round your answers to the nearest dollar.) stocks $ $ PRACTICE ANOTHER (b) What profit can the Carringtons expect to make on their investments over the year if they use their optimal investment strategy?…arrow_forward
- Cornerstones of Cost Management (Cornerstones Ser...AccountingISBN:9781305970663Author:Don R. Hansen, Maryanne M. MowenPublisher:Cengage Learning
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