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    EXERCISE 14-7 Selected Financial Ratios for Common Stockholders (LO2)

    Recent financial statements for the Madison Corporation, a company that sells drilling equipment, are given below:

    Madison Corporation
    Balance Sheet
    June 30
    Assets
    Current Assets:
    Cash $21, 000
    Accounts receivable, 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
    Bond 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
    Cost of goods sold 1,260,000
    Gross margin 840,000
    Selling and administrative expenses 660,000
    Net operating income 180,000
    Interest expense 30,000
    Net income before taxes 150,000
    Income taxes (30%) 45,000
    Net income $105,000

    In addition to the data in these statements, assume that Madison Corporation paid dividends of $3.15 per share during the year. Also assume that the company's common stock had a market price of $63 per share on June 30 and there is was no change in the number of outstanding shares of common stock during the fiscal year.

    Required:
    Compute the following financial ratios:

    1. Earnings per share.
    2. Dividend payout ratio.
    3. Dividend yield ratio.
    4. Price-earnings ratio.

    EXERCISE 14-8 Selected Financial Ratios for Common Stockholders (LO2)

    Refer to the financial statements for Madison Corporation above. Assets at the beginning of the year totaled $1,100,000, and the stockholders' equity totaled $725,000.

    Required:
    Compute the following financial ratios:

    1. Return of total assets.
    2. Return on common stockholders' equity.
    3. Was financial leverage positive or negative for the year? Explain.

    PROBLEM 14-11A 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 your help in analyzing the following data:

    Year 3 Year 2 Year 1
    Sales trend 132 118 108
    Current ratio 2.7 2.4 2.3
    Acid-test (quick) ratio 0.6 0.8 1.0
    Accounts receivable turnover 9.8 10.7 12.8
    Inventory turnover 6.4 7.8 8.4
    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 stockholders' 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 the 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. Are the earnings per share increasing or decreasing?
    g. Is the price-earnings ration 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 and explain how you arrived at you answer.

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

    Vicki Newport organized Newport Industries 10 years ago to produce and sell several electronic 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 $500,000 long-term loan from San Juan Bank, $80,000 or which will be used to bolster the Cash account and $420,000 of which will be used to modernize equipment. The company's financial statements for the two most recent years follow:

    Newport Industries
    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
    Property and equipment, net 1,410,000 1,300,000
    Total assets $2,915,000 $2,390,000
    Liabilities and Stockholders' Equity
    Liabilities:
    Current liabilities $703,000 $371,000
    Bond payable, 12% 500,000 500,000
    Total liabilities 1,203,000 871,000
    Stockholders' equity:
    Preferred stock, $25 par, 8% 300,000 300,000
    Common stock, $10 par value 550,000 550,000
    Retained earnings 862,000 669,000
    Total stockholders' equity 1,712,000 1,519,000
    Total liabilities and stockholders' equity $2,915,000 $2,390,000

    Newport Industry
    Comparative Income Statement and Reconciliation
    This Year Last Year
    Sales $4,960,000 $4,380,000
    Cost of goods sold 3,839,000 3,470,000
    Gross margin 1,121,000 910,000
    Selling and administrative expenses 651,000 550,000
    Net operating income 470,000 360,000
    Interest expense 60,000 60,000
    Net income before taxes 410,000 300,000
    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 60,000
    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 territories. Sales terms are 2/10, n/30. All sales are on account. The following ratios are typical of companies in this industry:

    Current ratio 2.5
    Acid-test (quick) ration 1.3
    Average collection period 17 days
    Average sale period 60 days
    Debt-to-equity ratio 0.90
    Times interest earned 6.0
    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 collection period. (The accounts receivable at the beginning of last year totaled $240,000.)
    e. The average sale period. (The inventory at the beginning of last year totaled $490,000.)
    f. The debt-to-equity ratio.
    g. The times interest 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 14-13A Financial Ratios for Common Stockholders (LO2)

    Refer to the financial statements and other data in problem 14-12A. 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 shareholders. 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 you client purchase shares of Newport Industry stock? Explain.

    ETHICS CHALLENGE (LO3, LO4)

    Mountain Aerosport was founded by Jurgen Prinz to produce a ski he had designed for doing aerial tricks. Up to this point, Jurgen has financed the company with his own savings and with cash generated by his business. However, Jurgen now faces a cash crisis. In the year just ended, an acute shortage of a vital tungsten steel alloy developed just as the company was beginning production for the Christmas season. Jurgen had been assured by his suppliers that the steel would be delivered in time to make Christmas shipments, but the suppliers had been unable to fully deliver on this promise. As a consequence, Mountain Aerosport had large stocks of unfinished skis at the end of the year and had been unable to fill all of the orders that had come from retailers for the Christmas season. Consequently, sales are below expectations for the year, and Jurgen does not have enough cash to pay his creditors.
    Well before the accounts payable were due, Jurgen visited a local bank and inquired about obtaining a loan. The loan officer at the bank assured Jurgen that there should not be any problem getting a loan to pay off his accounts payable - providing that on his most recent financial statements the current ratio was above 2.0, the acid-test ratio was above 1.0, and net operating income was at least four times the interest on the proposed loan. Jurgen promised to return later with a copy of his financial statements.
    Jurgen would like to apply for a $120 thousand six-month loan bearing an interest rate of 10% per year. The unaudited financial reports of the company appear below.

    Mountain Aerosport
    Comparative Balance Sheet
    As of December 31
    (in thousands of dollars)
    This Year Last Year
    Assets
    Current Assets:
    Cash $105 $225
    Accounts receivable, net 75 60
    Inventory 240 150
    Prepaid expenses 15 18
    Total current assets 435 453
    Property and equipment, net 405 270
    Total assets $840 $723
    Liabilities and Stockholders' Equity
    Current liabilities:
    Accounts payable $231 $135
    Accrued payables 15 15
    Total current liabilities 246 150
    Long-term liabilities 0 0
    Total liabilities 246 150
    Stockholders' equity:
    Common stock and additional paid-in capital 150 150
    Retained earnings 444 423
    Total stockholders' equity 594 573
    Total liabilities and stockholders' equity $840 $723

    Mountain Aerosport
    Income Statement
    For the Year Ended December 31, This Year
    (in thousands of dollars)
    Sales (all on account) $630
    Cost of goods sold 435
    Gross margin 195
    Selling and administrative expenses
    Selling expenses 63
    Administrative expenses 102
    Total selling and administrative expenses 165
    Net operating income 30
    Interest expense 0
    Net income before taxes 30
    Income taxes (30%) 9
    Net income $21

    Required:
    1. On the basis of the above unaudited financial statements and the statement made by the loan officer, would the company qualify for the loan?
    2. Last year Jurgen purchased and installed new, more efficient equipment to replace an older heat-treating furnace. Jurgen had originally planned to sell the old equipment but found that it is still needed whenever the heat-treating process is a bottleneck. When Jurgen discussed his cash flow problems with his brother-in-law, he suggested to Jurgen that the old equipment be sold or at least reclassified as inventory on the balance sheet since it could be readily sold. At present, the equipment is carried in the Property and Equipment account and could be sold for its net book value of $68 thousand. The bank does not require audited financial statements. What advise would you give to Jurgen concerning the machine?

    © BrainMass Inc. brainmass.com April 3, 2020, 5:46 pm ad1c9bdddf
    https://brainmass.com/business/financial-ratios/ratio-analysis-176213

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    EXERCISE 14-7 Selected Financial Ratios for Common Stockholders (LO2)

    Recent financial statements for the Madison Corporation, a company that sells drilling equipment, are given below:

    Madison Corporation
    Balance Sheet
    June 30
    Assets
    Current Assets:
    Cash $21, 000
    Accounts receivable, 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
    Bond 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
    Cost of goods sold 1,260,000
    Gross margin 840,000
    Selling and administrative expenses 660,000
    Net operating income 180,000
    Interest expense 30,000
    Net income before taxes 150,000
    Income taxes (30%) 45,000
    Net income $105,000

    In addition to the data in these statements, assume that Madison Corporation paid dividends of $3.15 per share during the year. Also assume that the company's common stock had a market price of $63 per share on June 30 and there is was no change in the number of outstanding shares of common stock during the fiscal year.

    Required:
    Compute the following financial ratios:

    1. Earnings per share.
    EPS = Net Income/Number of common shares outstanding
    Since the common stock value is 100,000 and the par value is $5, the number of shares is 100,000/5 = 20,000
    EPS = 105,000/20,000 = $5.25

    2. Dividend payout ratio.

    Dividend payout ratio = Dividend per share / Earnings per share = 3.15/5.25 = 60%

    3. Dividend yield ratio.

    Dividend yield ratio = Dividend per share/Market price
    = 3.15/63 = 5%

    4. Price-earnings ratio.

    Price - Earnings = Market Price/EPS = 63/5.25 = 12 times

    EXERCISE 14-8 Selected Financial Ratios for Common Stockholders (LO2)

    Refer to the financial statements for Madison Corporation above. Assets at the beginning of the year totaled $1,100,000, and the stockholders' equity totaled $725,000.

    Required:
    Compute the following financial ratios:

    1. Return of total assets.

    Return on total assets = (Net Income + Interest Expense X (1-tax rate)/Average total assets
    = (105,000 + 30,000 X (1-0.3))/((,100,000+1,300,000)/2)
    =126,000/1,200,000 = 10.5%

    2. Return on common stockholders' equity.

    Return on Equity = (Net Income - Preferred dividends)/Average equity
    =105,000/((725,000+800,000)/2) = 13.8%

    3. Was financial leverage positive or negative for the year? Explain.

    Financial leverage refers to the use of debt and the increase in return on equity as compared to return on assets. Financial leverage is positive if the ROE > ROA. In this case the financial leverage was positive since the ROE is greater than ROA.

    PROBLEM 14-11A 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 your help in analyzing the following data:

    Year 3 Year 2 Year 1
    Sales trend 132 118 108
    Current ratio 2.7 2.4 2.3
    Acid-test (quick) ratio 0.6 0.8 1.0
    Accounts receivable turnover 9.8 10.7 12.8
    Inventory turnover 6.4 7.8 8.4
    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 stockholders' 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 the 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?

    No it is not becoming easier to pay the bills. The reason is the increase in current ratio and the decrease in quick ratio. An increase in current ratio coupled with the decrease in receivables and inventory turnover indicates that the firm is converting assets in cash at a slower rate and so would find difficult to pay its bills.

    b. Are customers paying their accounts at least as fast now as they were in Year 1?

    The decrease in accounts receivable turnover implies that the customers are paying their accounts more slowly in year 3 as compared to year 1.

    c. Is the total of accounts receivable increasing, decreasing, or remaining constant?

    The total of accounts receivable is increasing. The reason is that sales are increasing and the accounts receivable turnover is decreasing. The average collection period is increasing and that combined with higher sales would imply that the total of accounts receivable is increasing.

    d. Is the level of inventory increasing, decreasing, or remaining constant?

    The level of inventory is possibly increasing. The inventory turnover is down indicating that inventory is there for more number of days. The sales have increased and assuming that the gross margin is the same, the cost of goods sold would have increased. With the number of days rising, the inventory value would increase.

    e. Is the market price of the company's stock going up or down?

    An increasing dividend yield with a constant dividend per share amount indicates that the market price of the stock is going down.

    f. Are the earnings per share increasing or decreasing?

    The earnings per share is increasing. The reason is the decrease in dividend payout ratio. Dividend payout ratio = DPS/EPS and since the DPS is constant and so for the ratio to decrease, the EPS has to increase

    g. Is the ...

    Solution Summary

    The solution explains the calculation of various ratios

    $2.19

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