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Liquidity and profitability ratios

The December 31, 1995 balance sheet for Spitco, Inc. is presented below.

Spitco, Inc. Balance Sheet
December 31, 1995
Current assets $40,000
Net fixed assets 20,000
Total $60,000
Accounts payable 11,000
Notes payable 12,000
Total $23,000
Long-term debt (10%) 12,000
Common equity 25,000
Total $60,000

Partial Income Statement for December 31, 1995
Net operating income $10,291
Less: interest income 1,200
Earnings before taxes $9,091
Less: taxes (34%) 3,091
Net income $ 6,000

a. Calculate Spitco's current ratio, net working capital, and return on total assets.
b. Spitco feels that its current ratio is too far below the industry average of 2.40. To improve their liquidity, the treasurer of Spitco has devised a plan to issue $12,000 in long-term debt at 12% and pay off its notes payable. The funds would be invested in marketable securities at 7% interest when not needed to finance the firm's seasonal asset needs. The notes payable would remain outstanding through the year. Assume this plan had been implemented for 1993. The net income was $5,500. Calculate what the firm's current ratio, net working capital, and return on total assets would have been.
c. Did Spitco improve their liquidity? What about their profitability?

Solution Summary

The solution contains the computation of current ratio, liquid ratio, return on assets, net working capital and comparing with the industry average and the measures to improve the liquidity.