Financial Ratios

Refer to the financial statements and other data in PROBLEM 14-12B. Assume that you are an account executive for a large brokerage house and that one of your clients has asked for a recommendation about the possible purchase of Newport Industry stock. You are not acquainted with the stock and for this reason wish to do some analytical work before making a recommendation.

PROBLEM 14-12A Common-Size Statements and Financial Rations for Creditors (LO1, LO3,LO4)

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

NEWPORT INDUSTRY Balance sheet in Common Size Format

Assets This year Last year
Current assets:
Cash 2.06% 5.86%
Marketable securities 0.00% 1.26%
Accounts receivable net 16.12% 12.13%
Inventory 32.25% 24.69%
Prepaid expenses 1.20% 1.67%
Total current assets 51.63% 45.61%
Plant and equipment, net 48.37% 54.39%
Total assets 100.00% 100.00%

Liabilities and Stockholder's Equity
Liabilities:
Current liabilities 24.12% 15.52%
Bonds payable, 17.15% 20.92%
Total liabilities 41.27% 36.44%
Stockholder's equity:
Preferred stock, $25 par, 8% 10.29% 12.55%
Common stock, $10 par 18.87% 23.01%
Retained earnings 29.57% 27.99%
Total stockholder's equity 58.73% 63.56%
Toal liabilities and equity 100.00% 100.00%

NEWPORT INDUSTRY Income statement in Common size
Comparative Income Statement
This year Last year
Sales 100.00% 100.00%
Less cost of goods sold 77.40% 79.22%
Gross margin 22.60% 20.78%
Less operating expenses 13.13% 12.56%
Net operating income 9.48% 8.22%
Less interest expense 1.21% 1.37%
Net income before taxes 8.27% 6.85%
Less income taxes (30%) 2.48% 2.05%
Net income 5.79% 4.79%

Problem 14-13A
Refer to the financial statements and other data in PROBLEM 14-12B. Assume that you are an account executive for a large brokerage house and that one of your clients has asked for a recommendation about the possible purchase of Newport Industry stock. You are not acquainted with the stock and for this reason wish to do some analytical work before making a recommendation.

Required:

1. You decide first to assess the well-being of the common stockholders. For both this year and last year, compute:
a. The earnings per share. There has been no change in preferred or common stock over the last two years.
b. The dividend yield ratio for common stock. The company's stock is currently selling for $38 per share; last year it sold for $35 per share.
c. The dividend payout ratio for common stock.
d. The price-earnings ratio. How do investors regard Newport Industry as compared to other companies in the industry? Explain.
e. The book value per share of common stock. Does the difference between market value and book value suggest that the stock is overpriced? Explain.
2. You decide next to assess the company's rate of return. Compute the following for both this year and last year:
a. The return on total assets. (Total assets at the beginning of last year were $2,230,000.)
b. The return on common stockholders' equity. (Stockholders' equity at the beginning of last year was $1,418,000.)
c. Is the company's financial leverage positive or negative? Explain.
3. Would you recommend that your client purchase shares of Newport Industry stock? Explain.