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, $20 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.

Assume 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 $60 per share; last year it sold for $55 per share.

c. The dividend payout ratio.

d. The price-earnings ratio. (Assume that the industry norm for the price-earnings ratio is 9)

e. The book value per share of common stock.

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 $2,986,000.)

d. The return on equity. (Stockholders’ equity at the beginning of last year was $1,806,000.)

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

Answer 1

Answers:

1a. Earnings per share (EPS)	=Net profit after tax / No. of shares outstanding
This Year	=693000 / 42500 = $ 16.31 per share
Last Year	=385000 / 42500 = $ 9.06 per share
1b. Dividend Yield Ratio	= Dividend per share / Price per share
This Year	=2.96/60.00 = 5%
Last Year	=2.47/55.00 = 4%
1c. Dividend Payout Ratio	= Dividend per share / Earning per share
This Year	= 2.96/16.31 = 18%
Last Year	= 2.47/9.06 = 27%
1d. Price earning ratio	= Current market price per share / Earning per share
This Year	=60/16.31 = 3.68 times
Last Year	=55/9.06 = 6.07 times
1e. Book Value per share of common stock
This Year & Last Year	= $20 per share
2a. Gross Margin percentage	= Gross Margin / Total Sales Revenue
This Year	=1765000 / 5800000 = 30.43%
Last Year	=1220000 / 4830000 = 25.26%
2b. Net Profit Margin percentage	= Net Profit / Total Sales Revenue
This Year	=693000 / 5800000 = 11.95%
Last Year	=385000 / 4830000 = 7.97%
2c. Return on total assets	= Net Operating Income / Total Assets
This Year	= 1080000 / 4013000 = 26.91%
Last Year	= 640000 / 3026000 = 21.15%
2d. Return on Equity	= Net Income / Shareholders Equity
This Year	= 693000 / 850000 = 81.53%
Last Year	= 385000 / 850000 = 45.29%

2e. Financial leverage is positive.

No.of shares outstanding = $850000/20 = 42500 shares

Dividend per share = 126000/42500 = 2.96 per share (This Year) , 105000/42500 = 2.47 per share (Last Year)