"CP 3-1. (Continued)The $90,000 proceeds indicates the 6,000 shares were sold at an averageprice of $15.00 each. The $15.00 represents a fairly low multiplier of200Z earnings of $2.61. The price/earnings ratio is 5.75X. Book valueper share (including the new shares) is $18.33 ($843,260/46,000), soonce again the price of $15 is fairly modest (81.8 percent of book value).If Mr. Thomas were to purchase 20 percent of the shares outstanding at$15 per share, the total cost would be: 92,000 shares (20 percent of 46,000)$15 price per share $138,000He would probably have difficulty justifying such an investment basedon the performance of the firm. There are no dividend payouts, so returnto the investor would have to come in the form of capital appreciation ifand when he was able to resell the shares. The prospects, at this point,would not appear to justify the purchase. This is particularly true whenone considers that Mr. Thomas would be buying a minority interest(20%) and would not have control of the firm.S3-65 Comprehensive Problem 2Sun Microsystems is a leading supplier of computer related products, including servers,workstations, storage devices, and network switches.In the letter to stockholders as part of the 2001 annual report, President and CEO Scott G.McNealy offered the following remarks:Fiscal 2001 was clearly a mixed bag for Sun, the industry, and the economy as a whole.Still, we finished with revenue growth of 16 percent ?and that?s signifit r ? e. sa good indicatiFor that, we owe a debt of gratitude to our employees worldwide, who aggressively broughtcosts down ? bre ing e ven a xc sitthe ing ne y cont w pr inue oduc d tots to market.The statement would not appear to be telling you enough. For example, McNealy says theyear was a mixed bag with revenue growth of 16 percent. But what about earnings? You candelve further by examining the income statement in Exhibit 1. Also, for additional analysis ofother factors, consolidated balance sheet(s) are presented in Exhibit 2.1. Referring to Exhibit 1, compute the annual percentage change in net income per commonshare-diluted (2nd numerical line from the bottom) for 1998 ?1999, 1999?2000, 2000 ?2001. 2. Also in Exhibit 1, compute net income/net revenue (sales) for each of the four years.Begin with 1998.3. What is the major reason for the change in the answer for question 2 between 2000 and2001? To answer this question for each of the two years, take the ratio of the major incomestatement accounts (which follow Exhibit 1 on the next page) to net revenues (sales). Cost of sales Research and development Selling, general and administrative expense Provision for income taxS3-66 Comprehensive Problem 2 (Continued)Exhibit 1SUN MICROSYSTEMS, INC.Summary Consolidated Statement of Income (in millions)2001 2000 1999 1998Dollars Dollars Dollars DollarsNet revenues .......................................$18,250 $15,721 $11,806 $9,862Costs and expenses:Cost of sales ...................................10,041 7,549 5,670 4,713Research and development ............2,016 1,630 1,280 1,029Selling, general andadministrative .............................4,544 4,072 3,196 2,826Goodwill amortization ...................261 65 19 4In-process research anddevelopment ...............................77 12 121 176Total costs and expenses ....................16,939 13,328 10,286 8,748Operating income ...............................1,311 2,393 1,520 1,114Gain (loss) on strategic investments ...(90) 208 — —Interest income, net ............................363 170 85 48Litigation settlement ...........................— — — —Income before taxes ...........................1,584 2,771 1,605 1,162Provision for income taxes .................603 917 575 407Cumulative effect of change inaccounting principle, net ................(54) — — —Net income .........................................$ 927 $1,854 $1,030 $ 755Net income per commonshare ?................................ diluted .$0.27 $0.55 $0.31 $0.24Shares used in the calculation of netincome per commonshare ?................................ diluted .3,417 3,379 3,282 3,1804. Compute return on stockholders ? equity for 2000 anand 2.5. Analyze your results to question 4 more completely by computing ratios 1, 2a, 2b, and 3b(all from this chapter) for 2000 and 2001. Actually the answer to ratio 1 can be found aspart of the answer to question 2, but it is helpful to look at it again.What do you think was the main contributing factor to the change in return on stockholders ?equity between 2000 and 2001? Think in terms of the Du Pont system of analysis.S3-67 Comprehensive Problem 2 (Continued)6. The average stock prices for each of the four years shown in Exhibit 1 were as follows: 1998 11¼ 1999 16¾ 2000 28½ 2001 9½Exhibit 2SUN MICROSYSTEMS, INC.Consolidated Balance Sheets (in millions) 2001 2000AssetsCurrent assets:Cash and cash equivalents ............................................................ $ 1,472 $ 1,849Short-term investments .................................................................387 626Accounts receivable, net of allowances of $410 in 2001 and $534 in 2000 ................................................................... 2,955 2,690Inventories .................................................................................... 1,049 557Deferred tax assets ........................................................................ 1,102 673Prepaids and other current assets ..................................................969482Total current assets ................................................................... 7,934 6,877Property, plant and equipment, net .................................................... 2,697 2,095Long-term Investments ..................................................................... 4,677 4,496Goodwill, net of accumulated amortization of $349 in 2001 and $88 in 2000 ............................................................................ 2,041 163Other assets, net .................................................................................832521 $18,181 $14,152S3-68 Comprehensive Problem 2 (Continued)Liabilities and Stockholders ? Equity Current liabilities:Short-term borrowings .................................................................. $ 3 $7Accounts payable .......................................................................... 1,050 924Accrued payroll-related liabilities ................................................488 751Accrued liabilities and other ......................................................... 1,374 1,155Deferred revenues and customer deposits .................................... 1,827 1,289Warranty reserve ..........................................................................314 211Income taxes payable ................................................................... 90 209Total current liabilities .............................................................. 5,146 4,546Deferred income taxes .......................................................................744 577Long-term debt and other obligations ...............................................1,7051,720Total debt .................................................................................. $ 7,595$ 6,843Commitments and contingenciesStockholders ? equity: Preferred stock, $0.001 par value, 10 shares authorized (1 share which has been designated as Series A Preferredparticipating stock); no shares issued and outstanding ............ ——Common stock and additional paid-in-capital, $0.00067 parvalue, 7,200 shares authorized; issued: 3,536 shares in 2001and 3,495 shares in 2000 .......................................................... 6,238 2,728Treasury stock, at cost: 288 shares in 2001 and 301 shares in 2000 ........................................................................... (2,435)(1,438)Deferred equity compensation ......................................................(73) (15)Retained earnings ......................................................................... 6,885 5,959Accumulated other comprehensive income (loss) ........................ (29)75Total stockholders ? ................................equity .......................10,5867,309 $18,181 $14,152a. Compute the price/earnings (P/E) ratio for each year. That is, take the stock priceshown above and divide by net income per common stock-dilution from Exhibit 1.b. Why do you think the P/E has changed from its 2000 level to its 2001 level? A briefreview of P/E ratios can be found under the topic of Price-Earnings Ratio Applied toEarnings per Share in Chapter 2.7. The book values per share for the same four years discussed in the preceding question were:1998 $1.181999 $1.552000 $2.292001 $3.26a. Compute the ratio of price to book value for each year.b. Is there any dramatic shift in the ratios worthy of note?S3-69 "