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Home / Questions / PROBLEM 15 16 Comprehensive Ratio Analysis LO2 LO3 LO4 You have just been hired as a loan...

PROBLEM 15 16 Comprehensive Ratio Analysis LO2 LO3 LO4 You have just been hired as a loan officer at Fairfield State Bank Your supervisor has given you a file containing a request from

PROBLEM 15–16 Comprehensive Ratio Analysis [LO2, LO3, LO4]

You have just been hired as a loan officer at Fairfield State Bank. Your supervisor has given you a file containing a request from Hedrick Company, a manufacturer of auto components, for a $1,000,000 five-year loan. Financial statement data on the company for the last two years are given below:

 

 

 

 

 

 

 

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$  320,000

 

$  420,000

Marketable securities . . . . . . . . . . . . . . . .

0

 

100,000

Accounts receivable, net . . . . . . . . . . . . . .

900,000

 

600,000

Inventory . . . . . . . . . . . . . . . . . . . . . . . . . .

1,300,000

 

800,000

Prepaid expenses . . . . . . . . . . . . . . . . . . .

80,000

 

60,000

Total current assets  . . . . . . . . . . . . . . . . . . .

2,600,000

 

1,980,000

Plant and equipment, net . . . . . . . . . . . . . . .

3,100,000

 

2,980,000

Total assets  . . . . . . . . . . . . . . . . . . . . . . . . .

$5,700,000

 

$4,960,000

Liabilities and Stockholders’ Equity

Liabilities:

Current liabilities . . . . . . . . . . . . . . . . . . . .

 

 

$1,300,000

 

 

 

$  920,000

Bonds payable, 10% . . . . . . . . . . . . . . . . .

1,200,000

 

1,000,000

Total liabilities . . . . . . . . . . . . . . . . . . . . . . . .

2,500,000

 

1,920,000

Stockholders’ equity:

Preferred stock, 8%, $30 par value . . . . . .

 

600,000

 

 

600,000

Common stock, $40 par value . . . . . . . . .

2,000,000

 

2,000,000

Retained earnings . . . . . . . . . . . . . . . . . . .

600,000

 

440,000

Total stockholders’ equity . . . . . . . . . . . . . . .

3,200,000

 

3,040,000

Total liabilities and stockholders’ equity . . . .

$5,700,000

 

$4,960,000

 

 

 

 

 

 

Sales (all on account) . . . . . . . . . . . . . . . . . .

$5,250,000

 

$4,160,000

Cost of goods sold . . . . . . . . . . . . . . . . . . . .

4,200,000

 

3,300,000

Gross margin  . . . . . . . . . . . . . . . . . . . . . . . .

1,050,000

 

860,000

Selling and administrative expenses . . . . . .

530,000

 

520,000

Net operating income . . . . . . . . . . . . . . . . . .

520,000

 

340,000

Interest expense . . . . . . . . . . . . . . . . . . . . . .

120,000

 

100,000

Net income before taxes . . . . . . . . . . . . . . . .

400,000

 

240,000

Income taxes (30%) . . . . . . . . . . . . . . . . . . .

120,000

 

72,000

Net income . . . . . . . . . . . . . . . . . . . . . . . . . .

280,000

 

168,000

Dividends paid:

Preferred stock . . . . . . . . . . . . . . . . . . . . .

 

48,000

 

 

48,000

Common stock  . . . . . . . . . . . . . . . . . . . . .

72,000

 

36,000

Total dividends paid . . . . . . . . . . . . . . . . . . .

120,000

 

84,000

Net income retained . . . . . . . . . . . . . . . . . . .

160,000

 

84,000

Retained earnings, beginning of year . . . . . .

440,000

 

356,000

Retained earnings, end of year  . . . . . . . . . .

$  600,000

 

$  440,000

 

 

Marva Rossen, who just two years ago was appointed president of Hedrick Company, admits that the company has been “inconsistent” in its performance over the past several years. But Rossen argues that the company has its costs under control and is now experiencing strong   sales

 

 

 

 

growth, as evidenced by the more than 25% increase in sales over the last year. Rossen also argues that investors have recognized the improving situation at Hedrick Company, as shown by the jump in the price of its common stock from $20 per share last year to $36 per share this year. Rossen believes that with strong leadership and with the modernized equipment that the $1,000,000 loan will enable the company to buy, profits will be even stronger in the future.

Anxious to impress your supervisor, you decide to generate all the information you can about the company. You determine that the following ratios are typical of companies in Hedrick’s industry:

 

Current ratio . . . . . . . . . . . . . .

2.3

Acid-test ratio . . . . . . . . . . . . .

1.2

Average collection period . . . .

31 days

Average sale period . . . . . . . .

60 days

Return on assets  . . . . . . . . . .

9.5%

Debt-to-equity ratio . . . . . . . . .

0.65

Times interest earned . . . . . . .

5.7

Price-earnings ratio  . . . . . . . .

10

 

Required:

1.       You decide first to assess the rate of return that the company is generating. Compute the fol- lowing for both this year and last year:

a.       The return on total assets. (Total assets at the beginning of last year were $4,320,000.)

b.       The return on common stockholders’ equity. (Stockholders’ equity at the beginning of last year totaled $3,016,000. There has been no change in preferred or common stock over the last two years.)

c.        Is the company’s financial leverage positive or negative? Explain.

2.       You decide next to assess the well-being of the common stockholders. For both this year and last year, compute:

a.       The earnings per share.

b.       The dividend yield ratio for common stock.

c.        The dividend payout ratio for common stock.

d.       The price-earnings ratio. How do investors regard Hedrick Company as compared to other companies in the industry? Explain.

e.       The book value per share of common stock. Does the difference between market value per share and book value per share suggest that the stock at its current price is a bargain? Explain.

f.       The gross margin percentage.

3.       You decide, finally, to assess creditor ratios to determine both short-term and long-term debt paying ability. For both this year and last year, compute:

a.       Working capital.

b.       The current ratio.

c.        The acid-test ratio.

d.       The average collection period. (The accounts receivable at the beginning of last year totaled $520,000.)

e.        The average sale period. (The inventory at the beginning of last year totaled $640,000.)

f.       The debt-to-equity ratio.

g.       The times interest earned.

4.       Make a recommendation to your supervisor as to whether the loan should be approved.

Jun 27 2020 View more View Less

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