MILESTONE I - Interpretation of Financial Ratios
Pecunious Products, Inc.'s financial results for the past three years are summarized below:
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Year 3
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Year 2
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Year 1
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Sales trend
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128.0
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115.0
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100.0
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Current ratio
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2.5
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2.3
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2.2
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Acid-test ratio
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0.8
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0.9
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1.1
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Accounts receivable turnover
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9.4
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10.6
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12.5
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Inventory turnover
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6.5
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7.2
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8.0
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Dividend yield
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7.1%
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6.5%
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5.8%
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Dividend payout ratio
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40%
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50%
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60%
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Return on total assets
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12.5%
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11.0%
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9.5%
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Return on equity
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14.0%
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10.0%
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7.8%
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|
Dividends paid per share*
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$1.50
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$1.50
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$1.50
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|
*There have been no changes in common stock outstanding over the three-year period.
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Your boss has asked you to review these results and then answer the following questions:
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 the 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. Is the earnings per share increasing or decreasing?
g. Is the price-earnings ratio going up or down?
h. Is the company employing financial leverage to the advantage of the common stockholders?
Required: Provide answers to each of the questions raised by your boss. Provide numbers to support your position. Let the numbers speak.
MILESTONE II - Common-Size Statements and Financial Ratios for a Loan Application
Paul Sabin organized Sabin Electronics 10 years ago to produce and sell several electronic devices on which he 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 Gulfport State Bank, $100,000 of which will be used to bolster the Cash account and $400,000 of which will be used to modernize equipment. The company's financial statements for the two most recent years follow:
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.
Required:
1. To assist in approaching the bank about the loan, Paul has asked you to 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 ratio.
d. The average collection period. (The accounts receivable at the beginning of last year totaled $250,000.)
e. The average sale period. (The inventory at the beginning of last year totaled $500,000.)
f. The operating cycle.
g. The total asset turnover. (The total assets at the beginning of last year were $2,420,000.)
h. The debt-to-equity ratio.
i. The times interest earned ratio.
2. Paul Sabin has also gathered the following financial data and ratios that are typical of companies in the electronics industry:
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Current ratio
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2.5
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Acid-test ratio
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1.3
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Average collection period
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18 days
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Average sale period
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60 days
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|
Debt-to-equity ratio
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0.90
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Times interest earned ratio
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6.0
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Comment on the results of your analysis in (1) above and compare Sabin Electronics' performance to the benchmarks from the electronics industry. Do you believe that the company is likely to have its loan application approved? If so, explain supporting your position with numbers. Let the numbers speak.
MILESTONE III - Financial Ratios for Assessing Profitability and Market Performance
Refer to the financial statements and other data provided by Milestone II. Assume that Paul Sabin has asked you to assess his company's profitability and stock market performance.
Required:
1. You decide first to assess the company's stock market performance. For both this year and last year, compute:
a. The earnings per share. There has been no change in common stock over the last two years.
b. The dividend yield ratio. The company's stock is currently selling for $40 per share; last year it sold for $36 per share.
c. The dividend payout ratio.
d. The price-earnings ratio. How do investors regard Sabin Electronics as compared to other companies in the industry if the industry norm for the price-earnings ratio is 12? 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 profitability. Compute the following for both this year and last year:
a. The gross margin percentage.
b. The net profit margin percentage.
c. The return on total assets. (Total assets at the beginning of last year were $2,300,000.)
d. The return on equity. (Stockholders' equity at the beginning of last year was $1,329,000.)
e. Is the company's financial leverage positive or negative? Explain.
3. Comment on the company's profit performance and stock market performance over the two-year period. Provide numbers to support your position. Let the numbers speak.