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E14-6, E14-8, P14-11, P14-15: Prepare and interpret ratios, common-size statements

See attached file for full problems description.

EXERCISE 14-6 Selected Financial Rations for Common Stockholders (LO2)
Selected financial data from the September 30 year-end statements of Kosanka Marine Services Company are given below:

Total assets....................................................................... $5,000,000
Long-term debt......................................................................... $750,000
Preferred stock, $100 par, 7%......................................................... $800,000
Total stockholders equity............................................................... $3,100,000
Interest paid on long-term debt................................................. $90,000
Net income .......................................................................... $470,000

Total assets at the beginning of the year were $4,800,000; total stockholder's equity was $2,900,000. there has been no change in the preferred stock during the year. The company's tax rate is 30%.

Required:
1. Compute the return on total assets.
2. Compute the return on common stockholder's equity.
3. Is the company's financial leverage positive or negative? Explain.

EXERCISE 14-8 Selected Financial Ratios (LO3, LO4)
Recent financial statements for Madison Corporation, a company that sells drilling equipment, are given below:

MADISON CORPORATION
Balance Sheet
June 30
Assets
Current Assets:
Cash ............................................................ $ 21,000
Accounts Recievable, net ........................ 160,000
Merchandise inventory ........................... 300,000
Prepaid expenses ................................. 9,000
Total current assets ................................ 490,000
Property and equipment, net ..................... 810,000
Total assets .......................................... $1,300,000

Liabilities and Stockholders' Equity
Liabilities:
Current liabilities ............................................. $ 200,000
Bonds payable, 10% ........................................ 300,000
Total liabilities .......................................... 500,000
Stockholders' equity:
Common stock, $5 par value .................................... $100,000
Retained earnings ................................................ 700,000

Total stockholders' equity ....................................... 800,000
Total liabilities and stockholders' equity ........................ $1,300,000

MADISON CORPORATION
Income Statement
For the Year Ended June 30
Sales......................................................... $2,100,000
Less cost of goods sold .................................... 1,260,000
Gross margin ................................................ 840,000
Less operating expenses .................................... 660,000
Net operating income ....................................... 180,000
Less interest expense ....................................... 30,000
Net income before taxes .................................... 150,000
Less income taxes ........................................... 45,000
Net income .................................................. $ 105,000

Account balances at the beginning of the company's fiscal year were: accounts receiveable, $140,000; and inventory, $260,000. All sales were on account.

Required:
Compute financial ratios as follows:
1. Gross margin percentage.
2. Current ratio.
3. Acid-test (quick) ratio.
4. Accounts receivable turnover in days.
5. Inventory turnover in days.
6. Debt-to-equity ratio.
7. Times interest earned.
8. Book value per share.

PROBLEM 14-11 Common-Size Statements and Financial Rations for Creditors (LO1, LO3,LO4)
Vicki Newport organized Newport Industry 10 years ago in order to produce and sell several electronics devices on which she had secured patents. Although the company has been fairly profitable, it is now experiencing a severe cash shortage. For this reason, it is requesting a $550,000 long-term loan form San Juan Bank.480,000of which be used to bolster the Cash account and $420,000 of which will be used to modernize certain key items of equipment. The company's financial statements for the two most recent years follows:

NEWPORT INDUSTRY
Comparative Balance Sheet
This Year Last Year
Assets
Current assets:
Cash ............................................. $ 60,000 $ 140,000
Marketable securities ........................... 0 30,000
Accounts receivable net ........................ 470,000 290,000
Inventory ......................................... 940,000 590,000
Prepaid expenses ............................... 35,000 40,000
Total current assets ............................. 1,505,000 1,090,000
Plant and equipment, net ....................... 1,410,000 1,300,000
Total assets ...................................... $2,915,000 $2,390,000

Liabilities and Stockholder's Equity
Liabilities:
Current liabilities ................................. $ 703,000 $ 371,000
Bonds payable, 125 ............................ 500,000 500,000
Total liabilities ................................... 1,203,000 871,000
Stockholder's equity:
Preferred stock, $25 par, 8% .................. 300,000 300,000
Common stock, $10 par ........................ 550,000 550,000
Retained earnings ............................... 862,000 669,000
Total stockholder's equity ..................... 1,712,000 1,519,000
Toal liabilities and equity ......................... $2,915,000 $2,390,000

NEWPORT INDUSTRY
Comparative Income Statement
This Year Last Year
Sales ...................................................... $4,960,000 $4,380,000
Less cost of goods sold ................................. 3,839,000 3,470,000
Gross margin.............................................. 1,121,000 910,000
Less operating expenses ................................. 651,000 550,000
Net operating income ..................................... 470,000 360,000
Less interest expense............ ............ ........... 60,000 60,000
Net income before taxes ... ............................ 410,000 300,000
Less income taxes (30%) ............................... 123,000 90,000
Net income ............................................ 287,000 210,000

Dividends paid:
Preferred dividends ...................................... 24,000 24,000
Common dividends ...................................... 70,000 70,000
Total dividends paid ..................................... 94,000 84,000
Net income retained ..................................... 193,000 126,000
Retained earnings, beginning of year .................... 669,000 543,000
Retained earnings, end of year ......................... $ 862,000 $ 669,000

During the past year, the company introduced several new product lines and raised the selling prices on a number of old product lines in order to improve its profit margin. The company also hired a new sales manager, who has expanded sales into several new in territories. Sales terms are 2/10, n/30. All sales are on account. The following ratios are typical of firms in this industry:

Current ratio ...................................... 2.5 to 1
Acid-test (quick) ratio........................... 1.3 to 1
Average age of receivables ..................... 17 days
Inventory turnover in days ....................... 60 days
Debt-to-equity ratio ............................. 0.90 to 1
Times interest earned ............................ 6.000 times
Return on total assets ............................ 13%
Price-earnings ratio ............................ 12

Required:
1. To assist the San Juan Bank in making a decision about the loan, compute the following ratios for both this year and last year.
a. The amount of working capital.
b. The current ratio.
c. The acid-test (quick) ratio.
d. The average age of receivables, (The accounts receivable at the beginning of last year totaled $240,000.)
e. The inventory turnover in days. (The inventory at the beginning of last year totaled $490,000.)
f. The debt-to-equity ratio.
g. The number of times interest was earned.

2. For both this year and last year:
a. Present the balance sheet in common-size format.
b. Present the income statement in common-size format down through net income.
3. Comment on the results of your analysis in (1) and (2) above and make a recommendation as to whether or not the loan should be approved.

PROBLEM 14-15 Interpretation of Financial ratios (LO1, LO2, LO3)
Shannon Michaels is interested in the stock of Acelicom, a company that sells building materials to the construction industry. Before purchasing the stock, Shannon would like to learn as much as possible about the company. However, all he has to go on is the current year's (Year 3) annual report, which contains no comparative data other than the summary of ratios given below:

Year 3 Year 2 Year 1
Sales trend 132 118 108
Current ratio 2.7:1 2.4:1 2.3:1
Acid-test (quick) ratio 0.6:1 0.8:1 1.0:1
Accounts receivable turnover 9.8 times 10.7 times 12.8 times
Inventory turnover 6.4 times 7.8 times 8.4 times
Dividend yield 7.4% 6.8% 5.7%
Dividend payout ratio 42% 52% 62%
Return on total assets 12.8% 11.5% 9.8%
Return on common equity 15.1% 10.5% 8.6%
Dividends paid per share $1.40 $1.40 $1.40
*There have been no changes in common stock outstanding over three-year period.

Shannon would like answers to a number of questions about the trend of events in Acelicom over the last three years. His questions are:

a. Is it becoming easier for the company to pay its bills as they come due?
b. Are customers paying their accounts at least as fast now as they were in Year 1?
c. Is the total of accounts receivable increasing, decreasing, or remaining constant?
d. Is the level of inventory increasing, decreasing, or remaining constant?
e. Is the market price of the company's stock going up or down?
f. Is the amount of earnings per share increasing or decreasing?
g. Is the price-earnings ratio going up or down?
h. Is the company employing financial leverage to the advantage of the common stockholders?

Required:
Answer each of Shannon's questions using the data given above. In each case, explain how you arrived at your answer.

PROBLEM 14-19 Financial Rations for Common Stockholders (LO2)
(Problem 14-20 and Problem 14-21 delve more deeply into the data presented below. Each problem is independent.) Farison Labs was organized several years ago to produce and market several new "miricle drugs." The company is small but growing, and you are considering the purchase of some of its common stock as an investment. The following data o n the company are available for the past two years.

Farizon Labs
Comparative Income Statement
For the Year ended December 31
This Year Last Year
Sales ................................................... $20,600,000 $15,500,000
Less cost of goods sold .............................. 13,184,000 9,145,000
Gross margin........................................... 7,416,000 6,355,000
Less operating expenses .............................. 5,400,000 4,700,000
Net operating income .................................. 2,016,000 1,655,000
Less interest expense............... .................... 240,000 240,000
Net operating income before taxes ................... 1,776,000 1,415,000
Less income taxes (30%) ............................. 532,000 424,500
Net income .............................................. $ 1,243,200 $ 990,500

Farizon Labs
Comparative Retained Earning Statement
For the Year ended December 31
This Year Last Year
Retained earnings, January 1 ....................... $2,390,500 $19,900,000
Add net income (above) ............................. 1,243,000 990,500
Total .................................................. 3,633,700 2,890,500
Deduct cash dividends paid:
Preferred dividends ........................,......... 80,000 80,000
Common dividends ................................... 540,000 420,000
Total dividends paid .................................. 620,000 500,000
Retained earnings, December 31...................... $ 3,013,700 $2,390,500

Farizon Labs
Comparative Balance Sheet
December 31
This Year Last Year
Current assets:
Cash ................. $ 153,700 $ 190,500
Accounts receivable, net .......................... 1,440,000 680,000
Inventory ........................................... 2,810,000 1,240,000
Prepaid expenses .................................. 210,000 190,000
Total current assets ................................ 4,613,700 2,300,500
Plant and equipment, net .......................... 5,330,000 5,560,000
Total assets ........................................ $9,943,700 $7,860,500

Liabilities and Stockholders' Equity
Liabilities:
Current liabilities .......................... $2,430,000 $970,000
Bonds payable, 12% ..................... 2,000,000 2,000,000
Total liabilities ................. 4,430,000 2,970,000

Stockholders' equity:
Preferred stock, 8%, $10 par value ..... 1,000,000 1,000,000
Common stock, $5 par value ...... 1,500,000 1,500,000
Retained earnings .............. 3,013,700 2,390,500
Total stockholders' equity ................ 5,513,700 4,890,500
Total liabilities and stockholders' equity .......... $9,943,700 $7,860,500

After some research, you have determined that the following ratios are typical of firms in the industry in which Farizon Labs operates.

Dividend yield ratio....................................... 3.3%
Dividend payout ratio ................................... 47.7%
Price-earnings ratio ..................................... 17.3%
Return on total assets .................................... 15.8%
Return on common equity .............................. 22.5%

The company's common stock is currently selling for $55 per share. Last year the stock sold for 440 per share.
There has been no change in the preferred or common stock outstanding over the last years.

Required:
1. In analyzing the company, you decide first to compute the earnings per share and related ratios. For both last year and this year, compute:
a. the earnings per share.
b. The dividend yield ratio.
c. The dividend payout ratio.
d. The price-earning ratio.
e. The book value per share of common stock.
f. The gross margin percentage.
2. you decide next to determine the rate of return that the company is generating. For both last year and this year, compute:
a. The return on total assets. 9Total assets were $6,349,500 at the beginning of last year.)
b. The return on common stockholders' equity. (Common stockholders' equity was $3,279,500 at the beginning of last year.)
c. Is financial leverage positive or negative? Explain.
3. Based on your work in (1) and (2) above, does the company's common stock seem to be an attractive investment? Explain.

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For workings and analysis see the Excel file attached.

In financial analysis, we need qualitative information and try to read between the numbers. We have to ask all the right questions. Over the years, there are some ratios, which have become more popular and handy for rule of thumb analysis of financial statements. Our purpose in this note is not deride them but to advice the reader to use them properly to derive the correct results.

Ratio analysis can also help us to check whether a business is ...

Solution Summary

The solution provides details of the answers together with explanations of the problems.

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