Question

Comparative financial statements for Heritage Antiquing Services for the fiscal year ending December 31 appear on the following page. The company did not issue any new common or preferred stock during the year. A total of 600 thousand shares of common stock were outstanding. The interest rate on the bond payable was 10%, the income tax rate was 40%, and the dividend per share of common stock was $0.75. The market value of the company’s common stock at the end of the year was $26. All of the company’s sales are on account.

Heritage Antiquing Services Comparative Balance Sheet (dollars in thousands)
	This Year			Last Year
Assets
Current assets:
Cash	$	1,080		$	1,210
Accounts receivable, net		9,000			6,500
Inventory		12,000			10,600
Prepaid expenses		600			500
Total current assets		22,680			18,810
Property and equipment:
Land		9,000			9,000
Buildings and equipment, net		36,800			38,000
Total property and equipment		45,800			47,000
Total assets	$	68,480		$	65,810
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable	$	18,500		$	17,400
Accrued payables		900			700
Notes payable, short term		-			100
Total current liabilities		19,400			18,200
Long-term liabilities:
Bonds payable		8,000			8,000
Total liabilities		27,400			26,200
Stockholders' equity:
Preferred stock		1,000			1,000
Common stock		2,000			2,000
Additional paid-in capital		4,000			4,000
Total paid-in capital		7,000			7,000
Retained earnings		34,080			32,610
Total stockholders' equity		41,080			39,610
Total liabilities and stockholders' equity	$	68,480		$	65,810

Heritage Antiquing Services Comparative Income Statement and Reconciliation (dollars in thousands)
	This Year			Last Year
Sales	$	66,000		$	64,000
Cost of goods sold		43,000			42,000
Gross margin		23,000			22,000
Selling and administrative expenses:
Selling expenses		11,500			11,000
Administrative expenses		7,400			7,000
Total selling and administrative expenses		18,900			18,000
Net operating income		4,100			4,000
Interest expense		800			800
Net income before taxes		3,300			3,200
Income taxes		1,320			1,280
Net income		1,980			1,920
Dividends to preferred stockholders		60			400
Net income remaining for common stockholders		1,920			1,520
Dividends to common stockholders		450			450
Net income added to retained earnings		1,470			1,070
Retained earnings, beginning of year		32,610			31,540
Retained earnings, end of year	$	34,080		$	32,610

Part IV

Use the traditional DuPont analysis to decompose the return on common stockholder’s equity (ROE) into its three components, and comment on Heritage Antiquing Services’ performance.

Part 5

Compute the Altman’s Z bankruptcy score for financial risk manager for this year. (8 points)

Altman's Z bankruptcy predictor: 3.3(Earnings before taxes / Total assets) + 1.2(Working capital / Total assets) +.6(Market value of equity / book value of debt) + 1.4(Retained earnings / Total assets) + 1(Revenue / Total assets).

Altman's Z bankruptcy predictor

=

3.3 (                  ) + 1.2(                ) + .6(                ) + 1.4(                    ) + 1(                )

=                          +                              +                              +                         +                         

=

Note:

Z < 1.8 indicates high bankruptcy risk within 1 year

Z > 3.0 indicates low bankruptcy risk within 1 year

Answer 1

Part IV]

ROE = (net income / sales) * (sales / total assets) * (total assets / total stockholders equity)

(net income / sales) = net proft margin

(sales / total assets) = total asset turnover

(total assets / total stockholders equity) = equity multiplier

This year :

ROE = (net income / sales) * (sales / total assets) * (total assets / total stockholders equity)

ROE = (1,980 / 66,000) * (66,000 / 68,480) * (68,480 / 41,080)

ROE = 0.030 * 0.964 * 1.667

ROE = 0.0482, or 4.82%

Last year :

ROE = (net income / sales) * (sales / total assets) * (total assets / total stockholders equity)

ROE = (1,920 / 64,000) * (64,000 / 65,810) * (65,810 / 39,610)

ROE = 0.031 * 0.972 * 1.661

ROE = 0.0500, or 5.00%

Heritage Antiquing Services’ performance is driven mostly by a high equity multiplier. It uses a high proportion of debt to improve ROE. Net profit margin is a low contributor to ROE.

Part 5]

Altman’s Z bankruptcy score = 3.3(Earnings before taxes / Total assets) + 1.2(Working capital / Total assets) + 0.6(Market value of equity / book value of debt) + 1.4(Retained earnings / Total assets) + 1(Revenue / Total assets)

Earnings before taxes = operating income

working capital = current assets - current liabilities = 22,680 - 19,400 = 3,280

Market value of equity = shares outstanding * price per share = 600,000 * 26 = 15,600,000

book value of debt = total liabilities

Altman’s Z bankruptcy score = 3.3(4,100 / 68,480) + 1.2(3,280 / 68,480) + 0.6(15,600,000 / 27,400) + 1.4(34,080 / 68,480) + 1(66,000 / 68,480)

Altman’s Z bankruptcy score = 343

As it has a high Altman’s Z bankruptcy score, there is low bankruptcy risk within 1 year