Problem - You have just been hired as a financial analyst for Lydex Company, a manufacturer of safety helmets. Your boss has asked you to perform a comprehensive analysis of the company's financial statements, including comparing Lydex's performance to its major competitors. The company's financial statements for the last two years are as follows:
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Lydex Company
Comparative Balance Sheet
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This Year
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Last Year
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Assets
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Current assets:
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Cash
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$980,000
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$1,220,000
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Marketable securities
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0
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300,000
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Accounts receivable, net
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2,780,000
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1,880,000
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Inventory
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3,620,000
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2,200,000
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Prepaid expenses
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260,000
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200,000
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Total current assets
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7,640,000
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5,800,000
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Plant and equipment, net
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9,560,000
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9,070,000
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Total assets
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$17,200,000
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$14,870,000
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Liabilities and Stockholders' Equity
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Liabilities:
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Current liabilities
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$4,030,000
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$3,020,000
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Note payable, 10%
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3,680,000
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3,080,000
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Total liabilities
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7,710,000
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6,100,000
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Stockholders' equity:
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Common stock, $75 par value
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7,500,000
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7,500,000
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Retained earnings
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1,990,000
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1,270,000
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Total stockholders' equity
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9,490,000
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8,770,000
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Total liabilities and stockholders' equity
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$17,200,000
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$14,870,000
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Lydex Company
Comparative Income Statement and Reconciliation
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This Year
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Last Year
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Sales (all on account)
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$15,880,000
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$13,780,000
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Cost of goods sold
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12,704,000
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10,335,000
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Gross margin
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3,176,000
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3,445,000
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Selling and administrative expenses
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1,208,000
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1,612,000
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Net operating income
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1,968,000
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1,833,000
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Interest expense
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368,000
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308,000
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Net income before taxes
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1,600,000
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1,525,000
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Income taxes (30%)
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480,000
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457,500
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Net income
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1,120,000
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1,067,500
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Common dividends
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400,000
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533,750
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Net income retained
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720,000
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533,750
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Beginning retained earnings
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1,270,000
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736,250
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Ending retained earnings
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$1,990,000
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$1,270,000
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To begin your assigment you gather the following financial data and ratios that are typical of companies in Lydex Company's industry:
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Current ratio
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2.4
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Acid-test ratio
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1.1
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Average collection period
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32 days
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Average sale period
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60 days
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Return on assets
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9.5 %
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Debt-to-equity ratio
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.68
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Times interest earned ratio
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5.8
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Price-earnings ratio
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10
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Required: You decide first to assess the company's performance in terms of debt management and profitability. Compute the following for both this year and last year:
a. The times interest earned ratio.
b. The debt-to-equity ratio.
c. The gross margin percentage.
d. The return on total assets. (Total assets at the beginning of last year were $13,090,000.)
e. The return on equity. (Stockholders' equity at the beginning of last year totaled $8,236,250. There has been no change in common stock over the last two years.)
f. Is the company's financial leverage positive or negative?