Mr. Wizard's Magic Shoppe had the following condensed balance ...

[cmoore54]

Mr. Wizard's Magic Shoppe had the following condensed balance sheet at the end of operation for 2010:
 
  Mr. Wizard's Magic Shoppe
  Balance Sheet
  December 31, 2010
  Cash 40,000 Current Liabilities 35,000
  Other current assets 60,000 Long-term Notes Payable 40,000
  Total current assets 100,000 Bonds Payable 50,000
  Investments 25,000 Capital Stock 150,000
  Fixed assets (net) 110,000 Retained earnings 80,000
  Land 120,000
  Total assets 355,000 Total Liabilities and Equity 355,000
  During 2011, the following occurred
  a. Mr. Wizard's sold some of its investments for 13,000 which resulted in a gain of
  300 after taxes. The gain (net of taxes) has been included in the company's 2011 net income.
  b. Additional land for a plant expansion was purchased for 25,000.
  c. Bonds payable were paid in the amount of 10,000.
  d. An additional 35,000 in capital stock was issued.
  e. Dividends of 15,000 were paid to stockholders.
  f. Net income for 2011 was 48,000 after allowing for 15,000 in depreciation.
  g. A second parcel of land was purchased through the issuance of 10,000 in bonds,
  and 5,000 in long-term notes payable.
  Required:
  a. Prepare a statement of cash flows for the year ended 12/31/2011.
  (check figure: ending cash balance = 72,500)
  b. Prepare a condensed balance sheet for Mr. Wizard's at December 31, 2011.

Question 2

Why is the price/earnings ratio a common and popular technique for evaluating stocks? Why do fast growing firms have higher P/E ratios? What is a long-run average P/E ratio for larger publicly traded firms in the United States?
 
  What are some limitations to using this technique to evaluate stock prices?

[Jmfn03]

Answer to Question 1

Mr. Wizard's Magic Shoppe
Statement of Cash Flow
For the Year Ended December 31, 2011
Cash balance (December 31,

Answer to Question 2

P/E ratios are common because the reasoning is intuitive, appealing, and the calculation is easy to make. The P/E implies information about the risk, timing, and magnitude of future cash flows. The long-run average P/E for U.S. stocks is about 16. Thus, for every current dollar of earnings, (or expected earnings in the next period) we pay around 16. If a firm is expecting earnings next year of 5 per share we might be willing to pay in the neighborhood of (16  5 ) 80 per share. Faster growing firms that will provide larger cash flows earlier than slower growing firms have higher P/Es. Riskier firms with more uncertain cash flows earn lower P/Es. Of course, this is the problem with P/E ratios, they are simply rules of thumb based on historical information and created without serious fundamental investigation. Still, P/Es serve as a useful first pass in evaluating equity values.