B

Week Five Exercise AssignmentFinancial Ratios

1. Liquidity ratios. Edison, Stagg, and Thornton have the following financial information at the close

of business on July 10:

Edison Stagg Thornton

Cash $6,000 $5,000 $4,000

Short-term investments 3,000 2,500 2,000

Accounts receivable 2,000 2,500 3,000

Inventory 1,000 2,500 4,000

Prepaid expenses 800 800 800

Accounts payable 200 200 200

Notes payable: short-term 3,100 3,100 3,100

Accrued payables 300 300 300

Long-term liabilities 3,800 3,800 3,800

a. Compute the current and quick ratios for each of the three companies. (Round calculations to two

decimal places.) Which firm is the most liquid? Why?

Edison

Stagg Thornton

Cash 6,000 5,000 4,000Short-term investments 3,000 2,500 2,000Accounts receivable 2,000 2,500 3,000Inventory 1,000 2,500 4,000Prepaid expenses 800 800 800Total Current Assets 12,800 13,300 13,800

Edison Stagg ThorntonAccounts payable 200 200 200Notes payable: short-term

3,100 3,100 3,100

Accrued payables 300 300 300Total Current Liabilities 3,600 3,600 3,600

I would say that Thornton has the most liquid because they have a larger inventory and Thornton can move their inventory quickly

B

Edison

Current ratio

$12,800 / 3,600 3.56

Quick ration ($6,000 + 3,000 + 2,000) / 3,600 3.06

Stagg

Current ratio

$13,300 / 3,600 3.69

Quick ration ($5,000 + 2,500 + 2,500) / 3,600 2.78

Thornton

Current ratio

$13,800 / 3,600 3.83

Quick ration ($4,000 + 2,000 + 3,000) / 3,600 2.5

2.      Computation and evaluation of activity ratios. The following data relate to Alaska Products, Inc:

  20X5 20X4

Net credit sales $832,000 $760,000 Cost of goods sold 530,000 400,000Cash, Dec. 31 125,000 110,000Average Accounts receivable 205,000 156,000Average Inventory 70,000 50,000Accounts payable, Dec. 31 115,000 108,000

Instructionsa. Compute the accounts receivable and inventory turnover ratios for

20X5. Alaska rounds all calculations to two decimal places.

     

       2. a. Accounts Receivable Turnover Ratio = Net Credit Sales / Average Accounts Receivable

$832,000 / 180,500 = 4.60

Inventory Turnover Ratio = Cost of Goods Sold / Average Inventory

$530,000 / 60,000 = 8.83

[($ 205,000 + 156,000) / 2 = $180,500]

[($70,000 + 50,000) / 2 = 60,000]

B

3. Profitability ratios, trading on the equity. Digital Relay has both preferred and common stock

outstanding. The company reported the following information for 20X7:

Net sales $1,750,000

Interest expense 120,000

Income tax expense 80,000

Preferred dividends 25,000

Net income 130,000

Average assets 1,200,000

Average common stockholders' equity 500,000

a. Compute the profit margin on sales ratio, the return on equity and the return on assets, rounding

calculations to two decimal places.

Profit margin on Sales = Net Income / Net sales= 130,000 / 1,750,000= 7.43%

Rate of Return on Assets = Net Income / Average Assets= 130,000 / 1,200,000= 10.83%

Return on Common stockholder’s equity= Net Income/Average common stockholder’s equity= 130,000 / 500,000= 26%

b. Does the firm have positive or negative financial leverage? Briefly explain.

The company has an interest expense of $120,000, which indicates that there is huge debt on the company. The debt capital ratio is extremely high. It seems that they are using or running on borrowed funds.

4.      Horizontal analysis. Mary Lynn Corporation has been operating for several years. Selected data from the 20X1 and 20X2 financial statements follow.

20X2

20X1

C $ $80,000

B

urrent Assets 86,000 P

roperty, Plant, and Equipment (net) 9

9,00090,000

Intangibles

25,000

50,000

Current Liabilities

40,800

48,000

Long-Term Liabilities

153,000

160,000

Stockholders’ Equity

16,200

12,000

Net Sales

500,000

500,000

Cost of Goods Sold

322,500

350,000

Operating Expenses

93,500

85,000

a. Prepare a horizontal analysis for 20X1 and 20X2. Briefly comment on the results of your work.

Mary Lynn Corporation

  20X2 20X1Increase / Decrease

      Amount PercentageCurrent Assets 86,000 80,000 6,000 7.50%

Property, Plant, and Equipment (net) 99,000 90,0009,000 10.00%

Intangibles 25,000 50,000 -25,000 -50.00%

Current Liabilities 40,800 48,000 -7,200 -15.00%

Long-Term Liabilities 153,000 160,000 -7,000 -4.38%

Stockholders’ Equity 16,200 12,000 4,200 35.00%

Net Sales 500,000 500,000 0 0.00%

Cost of Goods Sold 322,500 350,000 -27,500 -7.86%

Operating Expenses 93,500 85,000 8,500 10.00%

Example 86,000 - 80,000 = 6,000 ÷ 80,000 = 0.075 = 7.50%

Comments:

Decrease in current liabilities and increase in current assets.

There is no change in Net Sales, Operating expense has increased.

Decrease in long term liabilities, indicates the repayment of debts.

B

There is no change in Net Sales; Cost of goods sold has decreased

5.Vertical analysis. Mary Lynn Corporation has been operating for several years. Selected data from the

20X1 and 20X2 financial statements follow.

20X2 20X1Current Assets $86,000 $80,000 Property, Plant, and Equipment (net) 99,000 80,000 Intangibles 25,000 50,000 Current Liabilities 40,800 48,000 Long-Term Liabilities 153,000 150,000 Stockholders’ Equity 16,200 12,000 Net Sales 500,000 500,000 Cost of Goods Sold 322,500 350,000 Operating Expenses 93,500 85,000

a. Prepare a vertical analysis for 20X1 and 20X2. Briefly comment on the results of your work.

Mary Lynn Corporation

  20X2 20X1

         Current Assets 86,000 40.95% 80,000 36.36%

Property, Plant, and Equipment (net) 99,000 47.14% 90,000 40.91%

Intangibles 25,000 11.90% 50,000 22.73%

Total Assets 210,000 100.00% 220,000 100.00%

         Current Liabilities 40,800 19.43% 48,000 21.82%

Long-Term Liabilities 153,000 72.86% 160,000 72.73%

Stockholders’ Equity 16,200 7.71% 12,000 5.45%

Total Liabilities & Shareholder’s Equity 210,000 100.00% 220,000 100.00%

         Net Sales 500,000 100.00% 500,000 100.00%

Cost of Goods Sold 322,500 64.50% 350,000 70.00%

Operating Expenses 93,500 18.70% 85,000 17.00%

Example 86,000 ÷ 210,000 = 0.4095 = 40.95%

B

Current assets / Total assets

Comments:

There is a decrease in cost of goods sold, which will increase the net income.

Current Assets and Property Plant and equipment have increased in 20x2.

There is a decrease in current liabilities; however, long term liability is at the same level.

New investments have been made from increase in stockholder’s Equity.

6. Ratio computation. The financial statements of the Lone Pine Company follow.

LONE PINE COMPANYComparative Balance Sheets

December 31, 20X2 and 20X1 ($000 Omitted)2

0X2 20X1

Assets

Current Assets

Cash and Short-Term Investments

$400

$600

Accounts Receivable (net)

3,000

2,400

Inventories

3,000

2,300

Total Current Assets

$6,400

$5,300

Property, Plant, and Equipment

Land

$1,700

$500

Buildings and Equipment (net)

1,500

1,000

Total Property, Plant, and Equipment

$3,200

$1,500

Total Assets

$9,600

$6,800

Liabilities and Stockholders’ Equity

Current Liabilities

Accounts Payable

$2,800

$1,700

Notes Payable

1,100

1,900

B

Total Current Liabilities

$3,900

$3,600

Long-Term Liabilities

Bonds Payable

4,100

2,100

Total Liabilities

$8,000

$5,700

Stockholders’ Equity

Common Stock

$200

$200

Retained Earnings

1,400

900

Total Stockholders’ Equity

$1,600

$1,100

Total Liabilities and Stockholders’ Equity

$9,600

$6,800

LONE PINE COMPANYStatement of Income and Retained Earnings

For the Year Ending December 31,20X2 ($000 Omitted)N

et Sales* $36,000

Less: Cost of Goods Sold

$20,000

Selling Expense

6,000

Administrative Expense

4,000

Interest Expense

400

Income Tax Expense

2,000 32,400

Net Income

$3,600

Retained Earnings, Jan. 1

900

Ending Retained Earnings

$4,500

Cash Dividends Declared and Paid

3,100

Retained Earnings, Dec. 31

$1,400

*All sales are on account.

Instructions

B

Compute the following items for Lone Pine Company for 20X2, rounding all calcu lations to two

decimal places when necessary:

a. Quick ratio= Quick Assets ÷ Current Liabilities= 3,400 ÷ 3,900= 0.87:1

b. Current ratio= Current Assets ÷ Current Liabilities= 6,400 ÷ 3,900= 1.64:1

 c. Inventory-turnover ratio

= Cost of goods sold ÷ Average Inventory = 20,000 ÷ (3,000 + 2,300) / 2= 7.55

 d. Accounts-receivable-turnover ratio

= Net Credit Sales ÷ Average Net Accounts receivable = 36,000 ÷ (3,000 + 2,400) / 2= 13.33

 e. Return-on-assets ratio

= Net Income ÷ Average Total Assets = 3,600 ÷ (9,600 + 6,800) / 2= 43.90%

f. Net-profit-margin ratio

= Net Income ÷ Net Sales = 3,600 ÷ 36,000= 10%

 

g. Return-on-common-stockholders’ equity

= Net Income ÷ Average common-stockholders’ equity= 3,600 ÷ (1,600 + 1,100) / 2= 266.67%

 

h. Debt-to-total assets

= Total Liabilities ÷ Total Assets

B

= 8,000 ÷ 9,600= 0.83:1

 i. Number of times that interest is earned

 = Net Income before Income tax and interest expense ÷ Interest

expense= (3,600 + 2,000 + 400) ÷ 400= 15 Times