Question

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 $660,000 long-term loan from Gulfport State Bank, $180,000 of which will be used to bolster the Cash account and $480,000 of which will be used to modernize equipment. The company’s financial statements for the two most recent years follow:

Sabin Electronics
Comparative Balance Sheet
	This Year		Last Year
Assets
Current assets:
Cash	$	128,000	$	310,000
Marketable securities		0		13,000
Accounts receivable, net		685,000		460,000
Inventory		1,105,000		755,000
Prepaid expenses		34,000		38,000
Total current assets		1,952,000		1,576,000
Plant and equipment, net		2,061,000		1,450,000
Total assets	$	4,013,000	$	3,026,000
Liabilities and Stockholders Equity
Liabilities:
Current liabilities	$	880,000	$	460,000
Bonds payable, 12%		750,000		750,000
Total liabilities		1,630,000		1,210,000
Stockholders' equity:
Common stock, $15 par		850,000		850,000
Retained earnings		1,533,000		966,000
Total stockholders’ equity		2,383,000		1,816,000
Total liabilities and stockholders' equity	$	4,013,000	$	3,026,000

Sabin Electronics
Comparative Income Statement and Reconciliation
	This Year		Last Year
Sales	$	5,800,000	$	4,830,000
Cost of goods sold		4,035,000		3,610,000
Gross margin		1,765,000		1,220,000
Selling and administrative expenses		685,000		580,000
Net operating income		1,080,000		640,000
Interest expense		90,000		90,000
Net income before taxes		990,000		550,000
Income taxes (30%)		297,000		165,000
Net income		693,000		385,000
Common dividends		126,000		105,000
Net income retained		567,000		280,000
Beginning retained earnings		966,000		686,000
Ending retained earnings	$	1,533,000	$	966,000

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 3/10, 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 $410,000.)

e. The average sale period. (The inventory at the beginning of last year totaled $660,000.)

f. The operating cycle.

g. The total asset turnover. (The total assets at the beginning of last year were $2,986,000.)

h. The debt-to-equity ratio.

i. The times interest earned ratio.

j. The equity multiplier. (The total stockholders’ equity at the beginning of last year totaled $1,806,000.)

2. For both this year and last year:

a. Present the balance sheet in common-size format.

b. Present the income statement in common-size format down through net income.

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. (Round your answers to 2 decimal places.)
c. The acid-test ratio. (Round your answers to 2 decimal places.)
d. The average collection period. (The accounts receivable at the beginning of last year totaled $410,000.) (Round your intermediate calculations and final answers to 2 decimal place. Use 365 days in a year.)
e. The average sale period. (The inventory at the beginning of last year totaled $660,000.) (Round your intermediate calculations and final answers to 2 decimal place. Use 365 days in a year.)
f. The operating cycle. (Round your intermediate calculations and final answers to 2 decimal place. Use 365 days in a year.)
g. The total asset turnover. (The total assets at the beginning of last year were $2,986,000.) (Round your answers to 2 decimal places.)
h. The debt-to-equity ratio. (Round your answers to 2 decimal places.)
i. The times interest earned ratio. (Round your answers to 2 decimal places.)
j. The equity multiplier. (The total stockholders’ equity at the beginning of last year totaled $1,806,000.) (Round your answers to 2 decimal places.)

Answer 1

a. The amount of working capital.= Current Assets - Current Liabilities

This Year = 1,952,000 - 880000 = 1072000

Last Year = 1576000 - 460000 = 1116000

b. The current ratio.= Current Assets / Current Liabilities

This Year = 1,952,000 / 880000 = 2.22

Last Year = 1576000 / 460000 = 3.43

c. The acid-test ratio.= Quick Assets / Current Liabilities

This Year = (128000 + 685000 ) / 880000 = 0.92

Last Year = (310000 + 13000 + 460000) / 460000 = 1.702

d. The average collection period. = 365 / (Sales / Avg.Receivables)

This Year = 365 / ( 5800000 / ( 685000 + 460000 ) / 2 ) = 365 / (5800000 / 572500 ) = 365 / 10.13 = 36.03 Days

Last Year = 365 / ( 4830000 / ( 460000 + 410000 ) / 2 ) = 365 / (4830000 / 435000 ) = 365 / 11.10 = 32.88 Days

e. The average sale period.= 365 / (Cost of goods sold / Avg.Inventory)

This Year = 365 / ( 4035000 / ( 1105000 + 755000 ) / 2 ) = 365 / (4035000 / 930000 ) = 365 / 4.34 = 84.10 Days

Last Year = 365 / ( 3610000 / ( 755000 + 660000 ) / 2 ) = 365 / (3610000 / 707500 ) = 365 / 5.10 = 71.57 Days

f. The operating cycle = The average collection period.+ The average sale period.

This Year = 36.03 + 84.10 = 120.13 Days

Last Year = 32.88 + 71.57 = 104.45 Days

g. The total asset turnover. = Sales / Avg.Total Assets

This Year = 5800000 / ( 4013000 + 3026000 ) / 2 = 5800000 / 3519500 = 1.65

Last Year = 4830000 / ( 3026000 + 2986000 ) / 2 = 4830000 / 3006000 = 1.61

h. The debt-to-equity ratio.= Total Liabilities / Total Equity

This Year = 1630000 / 2383000 = 0.68

Last Year = 1210000 / 1816000 = 0.67

i. The times interest earned ratio.= Net operating income / Interest expense

This Year = 1080000 / 90000 = 12

Last Year = 640000 / 90000 = 7.11

j. The equity multiplier.= Total assets / Total stockholder's equity

This Year = 4013000 / 2383000 = 1.68

Last Year = 3026000 / 1816000 = 1.67