11. The effect of transactions on ratios You've been asked to tutor Madison, a finance student who doesn't feel comfortable about her 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 Madison to complete. The purpose of these exercises is to help Madison (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. \begin{tabular}{lclr} \hline \multicolumn{4}{|c}{ International Imports Inc.'s Pretransaction Statement of Financial Condition } \\ Cash & $15,000 & Accounts payable & $20,000 \\ Marketable securities & 10,000 & Wages payable & 20,000 \\ Accounts receivable & 470,000 & Taxes payable & 10,000 \\ Inventory & 500,000 & Notes payable & 50,000 \\ Prepaid expenses & 5,000 & Total current liabilities & 100,000 \\ \hline Total current assets & 1,000,000 & Long-term debt & 500,000 \\ \hline Gross plant and equipment & 1,500,000 & Common stock & 600,000 \\ Accumulated depreciation & 500,000 & Capital paid in excess of par & 350,000 \\ \hline Net plant and equipment & 1,000,000 & Retained earnings & 900,000 \\ \hline Total assets & & Total equity & 150,000 \\ \hline \end{tabular} 1 Cost of goods sold equals 40% of sales. 2 Interest expense equals 6% of the combined notes payable and long-term debt balances. 3 The average federal and state tax rate is 35%. Indicate if any of the listed financial statement accounts is affected by the following business transactions and whether the listed ratios will increase, decrease, or remain unchanged as a result of the transaction. (Hint: Assume that the business transaction occurs exactly as stated without interpreting it further. Do not consider any related transactions that may occur before or after the specified transaction. Assume there are 365 days in a year.) Business Transaction 2 A $500,00010-year bank loan is initiated, and the funds are placed in International Imports Inc. (2I)'s checking account. \begin{tabular}{|lc|} \hline Financial Account & Check if the Account Is Affected by the Specified Transaction \\ \hline Long-term debt & \\ \hline Marketable securities & \\ \hline Common stock & \\ \hline Cash & \\ \hline Gross plant and equipment & \\ \hline \end{tabular} \begin{tabular}{|c|c|} \hline Financial Ratio & Ratio's Behavior \\ \hline Fixed asset turnover & \\ \hline Debt ratio & \\ \hline Gross profit margin & \\ \hline Operating profit margin & \\ \hline Return on assets & \\ \hline Current ratio & \\ \hline \end{tabular}