Question

Togo Co. has the following financial statements.

Togo Co.
Income Statement for the Year
Sales revenue				$18,000,000
Less: Cost of goods sold				12,000,000
Gross profit				$ 6,000,000
Less: Operating expenses		$3,700,000
Depreciation		500,000		4,200,000
Operating income				$ 1,800,000
Less: Interest expense		$   100,000
Income taxes		800,000		900,000
Net income				$     900,000

Togo Co.
Balance Sheet at the End of the Year
Current assets: Cash		$1,000,000
Accounts receivable		3,600,000
Inventory		2,400,000		$7,000,000
Long-term assets: At cost		$5,000,000
Accumulated depreciation		3,000,000		2,000,000
Total assets				$  9,000,000
Liabilities & Shareholders’ Equity Current liabilities: Trade accounts payable		$2,250,000
Other current liabilities		750,000		$3,000,000
Long-term liabilities: Mortgage				1,500,000
Total liabilities				$4,500,000
Shareholders’ Equity: Common shares		$1,500,000
Retained earnings		3,000,000		4,500,000
Total liabilities & Shareholders’ Equity				$  9,000,000

Required

Use the information in the financial statements to answer the following questions:

(a)      Calculate the following ratios:

     (i) return on sales ratio (as a %)

    (ii) return on assets ratio (as a %)

   (iii) return on equity ratio (as a %)

(b)     Based on these ratios, comment on the profitability of the company.

(c)     Calculate the following ratios:

     (i) the current ratio

    (ii) the quick ratio

(d)     Based on these ratios, comment on the liquidity of the company.

(e)     Calculate the following ratios:

     (i) the gross profit to sales ratio (as a %)

    (ii) the ratio of operating expenses to sales (as a %)

   (iii) the operating income to sales ratio (as a %)

   (iv) the net income to sales ratio (as a %)

    (v) the interest cover ratio

   (vi) the dividend cover ratio

(f)      Based on these ratios, comment on the profitability of the company.

(g)     Calculate the following:

     (i) the receivables turnover ratio

    (ii) the receivables collection period

   (iii) the inventory turnover ratio

   (iv) the inventory holding period

    (v) the total asset turnover ratio

(h)     Based on these ratios, comment on the efficiency of the company.

(i)      Assume Togo Co.’s share price is $100 per share, and there are 100,000 shares in issue. Calculate the following:

     (i) the dividend payout ratio

    (ii) the earnings per share

   (iii) the price to earnings ratio

(j)      Based on these ratios, comment on the desirability of these shares as an investment.

Answer 1

Requirement a

(i) return on sales ratio = Operating Income / Sales = 1800000 / 18000000 = 10%

(ii) return on assets ratio = Net Income / Total Assets = 900000 / 9000000 = 10%

(iii) return on equity ratio = Net Income / Total Equity = 900000 / 4500000 = 20%

Requirement b

Th company seems to generate good profits and uses assets efficiently to generate profits.The shareholders funds are used efficiently to create wealth

Requirement c

(i) the current ratio = Current Assets / Current Liabilities = 7000000 / 3000000 = 2.33

(ii) the quick ratio = Quick Assets / Current Liabilities = (1000000 + 3600000 ) / 3000000 = 1.53

Requirement d

The current assets comfortably cover current liabilities

Requirement e

(i) the gross profit to sales ratio = Gross Profit / Sales = 6000000 / 18000000 = 33.33%

(ii) the ratio of operating expenses to sales = Operating expenses / Sales = 3700000 / 18000000 = 20.56%

(iii) the operating income to sales ratio = Operating Income / Sales = 1800000 / 18000000 = 10%

(iv) the net income to sales ratio = Net Income / Sales = 900000 / 18000000 = 5%

(v) the interest cover ratio = Operating Income / Interest expense = 1800000 / 100000 = 18 times

(vi) the dividend cover ratio = Net Income / Dividends = Dividend not provided

Requirement f

The company shows profitability but need to curtail expenses as gross profit is 33% and net income 5%

Requirement g

(i) the receivables turnover ratio = Sales / Receivables = 18000000 / 3600000 = 5

(ii) the receivables collection period = 365 / receivables turnover ratio = 365/ 5 = 73 days

(iii) the inventory turnover ratio = Cost of goods sold / Inventory = 12000000 / 2400000 = 5

(iv) the inventory holding period = 365 / inventory turnover ratio = 365 / 5 = 73 Days

(v) the total asset turnover ratio = Sales / Total Assets = 18000000 / 9000000 = 2

Requirement h

The company seems to use its assets efficiently

Requirement i

Dividend and market price not provided

(i) the dividend payout ratio = Dividend per share / Earning per share = Dividend per share / (Net Income / no. of outstanding shares = Dividend per share / (900000 / 100000 ) = Dividend per share / 9

(ii) the earnings per share = (Net Income / no. of outstanding shares ) = 900000 / 100000 = $9

(iii) the price to earnings ratio = Market price per share / EPS

Requirement j

The company is worth investing as ratios are positive