Question

Higginbotham, INC

Balance Sheet ($000)

Assets

Liabilities and Stockholder’s Equity

Cash                                  $ 1,500 Marketable Securities          2,500 Accounts Receivable          15,000 Inventory                            33,000     Tot. Curr. Assets           $52,000 Fixed Assets (net)               35,000     Total Assets                  $87,000

Accounts Payable                    $12,500 Notes Payable                            12,500     Tot. Current Liab.                $25,000 Long-term Debt                         22,000    Total Liabilities                    $47,000 Common Stock (par)                    5,000 Paid-in Capital                            18,000 Retained Earnings                       17,000      Total Stock Equity               $40,000 Tot Liab. And Stockholder             Equity                            $87,000

                                          Higginbotham, INC

Income Statement ($000)

Sales (all on credit)                                                        $130,000

Cost of Good Sold                                                      103,000

Gross Margin                                                              27,000

Operating Expenses                                                      16,000

Earnings before Interest and Taxes                                    11,000

Interest Expense                                                                   3,000

Earnings before Taxes                                                          8,000

Taxes                                                                         3,000

Earnings After Taxes                                                      $   5,000

Other Information:

Stock Price (Market Price)                    $9.50

Book Value per Share                            $8.00

Number of Shares                           5,000,000                                                                                                           

Use the Balance Sheet and Income Statement of Higginbotham, INC to answer the following:

  1. Calculate the following liquidity ratios.

1. 1. Current Ratio
   2. Quick Ratio
2. Calculate the following Activity Ratios.
   1. Average Collection Period
   2. Inventory Turnover
   3. Fixed Asset Turnover
   4. Total Asset Turnover
3. Calculate the following financial leverage ratios.
   1. Debt ratio
   2. Debt-to-equity ratio
   3. Times Interest Earned ratio
4. Calculate the following profitability ratios.
   1. Gross Profit Margin
   2. Net Profit Margin
   3. Return on investment
   4. Return on Stockholder’s equity
5. Calculate the following market-based ratios
   1. Price-to-earnings ratio
   2. Market price to book ratio

      6.   Express the return on stockholder’s equity ratio as a function of the net profit margin, total asset turnover, and equity multiplier.  

Answer 1

Calculate of Liquidity Ratios.

(a) Current Ratio

Current Ratio = Current Assets / Current Liabilties

Current Assets = $ 52000000

Current Liabilities = $ 25000000

Current Ratio = 52000000/25000000 = 2.08

(b) Quick Ratio

Quick Ratio = Quick Assets / Current Liabilties

Quick Assets = Current Assets - Inventories

= 52000000- 33000000

= 19000000

Quick Ratio = 19000000/25000000

= 0.76

Calculation of  Activity Ratios

(a) Average Collection Period: As average collection period measure the amount of time by which business will receive payments for credit sale made to customers, this ratio can be calculated as:

Average Collection Period = (Average Account Receivable / Sales)*365

=(15000000/130000000)*365

= 42.12 days

As previous year data is not given, we calculate Average collecton period using Account Receivable of current period only.

(b) Inventory Turnover Ratio: As this ratio measures the number of times for which inventory is coverted into sale or consumed in a given time period, calculation of Inventory turnover Ratio is as follow,

Inventory Turnover Ratio = Cost of Goods Sold / Average Inventory

= 103000000/33000000

= 3.12

As previous year data is not given, we calculate Inventory Turnover Ratio using Inventory of current period only.

(c)

Fixed Asset Turnover = Net Sale / Average Fixed Assets

= 130000000/35000000

=3.714

(d)

Total Asset Turnover = Net Sale / Total Assets

= 130000000/87000000

=1.494

Calculation of Financial Leverage Ratios

a.

Debt Ratio= Total Liabilites / Total Assets

we know Total Assets = Liabilities+ Equity

Total Liabilites= $ 47000000

Total Assets = $ 87000000

Debt Ratio = 47000000/87000000

= 0.54

b.

Debt to Equity Ratio= Total Debt / Equity

Total Liabilites= $ 47000000

Equity = $ 40000000 i.e. Total of Common Equity+ Paid In Capital + Retained Earnings

Debt to Equity Ratio= 47000000/40000000

= 1.175

Calculation of Profitability Ratio

a. Gross Profit Margin = (Gross Profit/ Sales) *100

= (27000000/130000000)*100

= 20.77%

b. Net Profit Margin = (Net Profit/ Sales) *100

= (5000000/130000000)*100

= 3.85%

c. Return on Investment: This ratio measures the earnings as a percentage of Capital Employed

ROI = Earning before Interest and Taxes / Capital Employed

EBIT = $ 11000000

Capital Employed = Long Term Debt + Equity = 22000000+40000000 = 62000000

ROI = (11000000/62000000) *100

= 17.74%   

Alternatively instead of Capital Employed, Total Assets can also be used for calculation sometimes.

d. Return on Equity Ratio : (Net Income / Equity)*100

= (5000000/40000000)*100

= 12.50%

Calculation of Market Based Ratio

a. Price to Earning Ratio = Market Price per Share / Earning Per Share

Earning Per Share = Net earning available to Equity Shareholder / Weightage Average No. of Shares

= 5000000/5000000

= $ 1 / share

Price to Earning Ratio = 9.5/1

= 9.5 TIMES

b. Market price to book ratio = Market Price per Share / Book Value per Share

= 9.5 / 8

= 1.19

Calculation of Return on stockholder’s equity ratio as a function of the net profit margin, total asset turnover, and equity multiplier.

Return on stockholder’s equity ratio = Net profit Margin * Total Asset Turnover * Equity Multiplier

=(Net Profit / Sales)* (Sales/ Total Assets) * (Total Assets / Total Equity)

Equity Multiplier = 87000000/40000000 = 2.175

= 3.85 * 1.494 * 2.175

= 12.51% ( similar to calculated above)