Question

In: Finance

Given the financial statements for Jones Corporation and Smith Corporation shown here:   a. To which one...

Given the financial statements for Jones Corporation and Smith Corporation shown here:

  a. To which one would you, as credit manager for a supplier, approve the extension of (short-term) trade credit? Why? Compute all ratios before answering.

  b. In which one would you buy stock? Why?

JONES CORPORATION

Current Assets

Liabilities

Cash.............................................

$ 20,000

Accounts payable..................

$100,000

Accounts receivable.....................

80,000

Bonds payable (long-term)....

80,000

Inventory......................................

50,000

Long-Term Assets

Stockholders’ Equity

Fixed assets..................................

$500,000

Common stock.......................

$150,000

Less: Accumulated depreciation

(150,000)

Paid-in capital......................

70,000

Net fixed assets*..........................

  350,000

Retained earnings.................

  100,000

    Total assets...............................

$500,000

Total liabilities and equity........

$500,000

Sales (on credit)....................................................................

$1,250,000

Cost of goods sold...............................................................

750,000

Gross profit..........................................................................

500,000

Selling and administrative expense†..................................

257,000

Less: Depreciation expense...............................................

50,000

Operating profit....................................................................

193,000

Interest expense....................................................................

8,000

Earnings before taxes...........................................................

185,000

Tax expense...........................................................................

$ 92,500

Net income............................................................................

$ 92,500

*Use net fixed assets in computing fixed asset turnover.

†Includes $7,000 in lease payments.

SMITH CORPORATION

Current Assets

Liabilities

Cash................................

$ 35,000

Accounts payable..................

$  75,000

Marketable securities......

7,500

Bonds payable (long-term)....

210,000

Accounts receivable........

70,000

Inventory........................

75,000

Long-Term Assets

Stockholders’ Equity

Fixed assets.....................

$500,000

Common stock......................

$75,000

Less: Accum. dep.........

(250,000)

Paid-in capital........................

30,000

Net fixed assets*............

  250,000

Retained earnings..................

47,500

Total assets................

$437,500

  Total liab. and equity...........

$437,500

*Use net fixed assets in computing fixed asset turnover.

SMITH CORPORATION

Sales (on credit)....................................................................

$1,000,000

Cost of goods sold................................................................

600,000

Gross profit...........................................................................

400,000

Selling and administrative expense†...................................

224,000

Less: Depreciation expense................................................

50,000

Operating profit....................................................................

126,000

Interest expense....................................................................

21,000

Earnings before taxes............................................................

105,000

Tax expense...........................................................................

52,500

Net income............................................................................

$52,500

†Includes $7,000 in lease payments.

Solutions

Expert Solution

We need to calculate the current ratio of both the firms:

Current ratio = Current Assets / Current Liabilities

Therefore for Smith Current Ratio = (Cash +AR + Inventory) / (AP) = (20000+80000+50000) / 100000 = 150000/100000 = 1.5

For Jones, Current ratio = (Cash +AR + Inventory + Marketable securities) / (AP) = (35000+70000+75000+7500) / 75000 = 187500/75000 = 2.5

Since, Jones has a better current ratio, it is advisable to lend short term finance to Jones. This is because Jones has more current assets to cover his liabilities and will lead to less chance of default in the bank loan. A current ratio of above 2 is favourable.

Fixed asset turnover ratio = Fixed assest / Net sales

The Fixed asset turnover ratio tells us how the assets of the company are being utilised to generate sales and helps in understanding the long term growth of the business.

For Smith, FA TO = 1250 / 350 = 3.57 and for Jones = 1000/250 = 4

This means that Jones is beter utilising its assets to generate sales.

Debt Equity ratio = Total Debt / Total equity

For Smith, Debt Equity Ratio = 80 / (150+70+100) = 0.25 and for Jones = 210 / (75+30+47.5) = 1.38

Since Smith has a lower debt equity ratio, it is advisable to invest in Smith. The FA TO ratio doesnt have a huge difference between the 2 companies, but the lower debt equity ratio signifies lower risk in future and less interest payments.

jeff jeffy answered 2 years ago
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