Question

Paul Sabin organized Sabin Electronics 10 years ago in order 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 $500,000 long-term loan from Gulfport State Bank, $100,000 of which will be used to bolster the cash account and $400,000 of which will be used to modernize certain key items of 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	$	50,900		$	79,000
Marketable securities		—			9,200
Accounts receivable, net		354,800			158,000
Inventory		710,000			316,000
Prepaid expenses		15,300			11,800
Total current assets		1,131,000			574,000
Plant and equipment, net		1,000,000			726,000
Total assets	$	2,131,000		$	1,300,000
Liabilities and Shareholders’ Equity
Liabilities:
Current liabilities	$	588,000		$	455,500
Bonds payable, 12%		300,000			300,000
Total liabilities		888,000			755,500
Shareholders’ equity:
Preferred shares, no par ($6; 14,320 shares issued)		179,000			179,000
Common shares, no par (unlimited authorized,        17,000 issued)		170,000			170,000
Retained earnings		894,000			195,500
Total shareholders’ equity		1,243,000			544,500
Total liabilities and shareholders’ equity	$	2,131,000		$	1,300,000

SABIN ELECTRONICS
Comparative Income Statement
	This Year			Last Year
Sales	$	3,700,000		$	3,400,000
Less: Cost of goods sold		2,847,000			2,680,000
Gross margin		853,000			720,000
Less: Operating expenses		481,000			427,000
Net operating income		372,000			293,000
Less: Interest expense		36,000			36,000
Net income before taxes		336,000			257,000
Less: Income taxes (30%)		100,800			77,100
Net income		235,200			179,900
Dividends paid:
Preferred dividends		20,000			20,000
Common dividends		66,600			58,450
Total dividends paid		86,600			78,450
Net income retained		148,600			101,450
Retained earnings, beginning of year		525,400			423,950
Retained earnings, end of year	$	674,000		$	525,400

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 2/10, n/30. All sales are on account. Assume that the following ratios are typical of firms in the electronics industry:

Current ratio		2.5	to 1
Acid-test (quick) ratio		1.3	to 1
Average age of receivables		18	days
Inventory turnover in days		60	days
Debt-to-equity ratio		0.90	to 1
Times interest earned		6.0	times
Return on total assets		13	%
Price–earnings ratio		12

Required:
1.	To assist the Gulfport Bank in making a decision about the loan, compute the following ratios for both this year and last year (Use 365 days a year. Round your intermediate calculations to 1 decimal place. Round Debt-to-equity ratio to 3 decimal places and other answers to 2 decimal places.):

a.	The amount of working capital.
b.	The current ratio.
c.	The acid-test (quick) ratio.
d.	The average age of receivables (the accounts receivable at the beginning of last year totalled $156,000).
e.	The inventory turnover in days (the inventory at the beginning of last year totalled $312,000).
f.	The debt-to-equity ratio.
g.	The times interest earned.

2.	For both this year and last year:

(a)	Present the balance sheet in common-size format. (Leave no cells blank - be certain to enter "0" wherever required. Round your answers to 1 decimal place.)

(b)	Present the income statement in common-size format down through net income. (Input all values as positive values. Round your answers to 1 decimal place.)

Answer 1

Ans. A	Working capital =     Total current assets - Total current liabilities
	This year	$1,131,000 - $588,000	$543,000
	Last year	$574,000 - $455,500	$118,500
Ans. B	Current ratio   =   Total current assets / Total current liabilities
	This year	$1,131,000 / $588,000	1.92 : 1
	Last year	$574,000 / $455,500	1.26 : 1
Ans. C	Acid test ratio   =   (Total current assets - Inventory - Prepaid expenses) / Total current liabilities
	This year	($1,131,000 - $710,000 - $15,300) / $588,000	0.69 : 1
	Last year	($574,000 - $316,000 - $11,800) / $455,500	0.54 : 1
Ans. D	Average age of receivables   =   No. of days in year / Net credit sales * Average accounts receivables
	This year	365 / $3,700,000 * $256,400	25.29	days
	Last year	365 / $3,400,000 * $157,000	16.85	days
	*Average receivable = (Beginning receivables + Ending receivables) / 2
	This year	($158,000 + $354,800) / 2	$256,400
	Last year	($156,000 + $158,000) / 2	$157,000
Ans. E	Inventory turnover in days =   No. of days in year / Cost of goods sold * Average inventory
	This year	365 / $2,847,000 * $513,000	65.77	days
	Last year	365 / $2,680,000 * $314,000	42.76	days
	*Average inventory = (Beginning inventory + Ending inventory) / 2
	This year	($316,000 + $710,000) / 2	$513,000
	Last year	($312,000 + $316,000) / 2	$314,000
Ans. F	Debt to equity ratio   =   Total liabilities / Total stockholder's equity
	This year	$888,000 / $1,243,000	0.71
	Last year	$755,500 / $544,500	1.39
Ans. G	Time interest earned = Net operating income / Interest expenses
	This year	$372,000 / $36,000	10.33	times
	Last year	$293,000 / $36,000	8.14	times
Ans. 2a	SABIN ELECTRONICS
	Common - Size Balance Sheets
		This Year		Last Year
		Amount	%	Amount	%
	Assets
	Current Assets:
	Cash	$50,900	2.4%	$79,000	6.1%
	Marketable securities	$0	0.0%	$9,200	0.7%
	Accounts receivable (net)	$354,800	16.6%	$158,000	12.2%
	Inventory	$710,000	33.3%	$316,000	24.3%
	Prepaid expenses	$15,300	0.7%	$11,800	0.9%
	Total current assets	$1,131,000	53.1%	$574,000	44.2%
	Plant and equipment (net)	$1,000,000	46.9%	$726,000	55.8%
	Total assets	$2,131,000	100.0%	$1,300,000	100.0%
	Liabilities and Stockholder's Equity:
	Liabilities:
	Current Liabilities	$588,000	27.6%	$455,500	35.0%
	Bonds payable, 12%	$300,000	14.1%	$300,000	23.1%
	Total liabilities	$888,000	41.7%	$755,500	58.1%
	Stockholder's equity:
	Preferred shares	$179,000	8.4%	$179,000	13.8%
	Common shares	$170,000	8.0%	$170,000	13.1%
	Retained earnings	$894,000	42.0%	$195,500	15.0%
	Total stockholder's equity	$1,243,000	58.3%	$544,500	41.9%
	Total liabilities and owner's equity	$2,131,000	100.0%	$1,300,000	100.0%
	*In a common size balance sheet, all percentages are calculated on the base of total assets.
	Amount is percentage for This year =   Particular amount of This year / Total assets * 100
	Amount is percentage for Last year =   Particular amount of Last year / Total assets * 100
Ans. 2b	SABIN ELECTRONICS
	Common - Size Income Statements
		This Year		Last Year
		Amount	%	Amount	%
	Sales	$3,700,000	100.00%	$3,400,000	100.00%
	Cost of goods sold	$2,847,000	76.95%	$2,680,000	78.82%
	Gross margin	$853,000	23.05%	$720,000	21.18%
	Operating expenses	$481,000	13.00%	$427,000	12.56%
	Net operating income	$372,000	10.05%	$293,000	8.62%
	Interest expense	$36,000	0.97%	$36,000	1.06%
	Net income before taxes	$336,000	9.08%	$257,000	7.56%
	Income taxes	$100,800	2.72%	$77,100	2.27%
	Net income	$235,200	6.36%	$179,900	5.29%
	*In a common size income statement, all percentages are calculated on the base of sales.
	Amount is percentage for This year =   Particular amount of This year / Sales * 100
	Amount is percentage for Last year =   Particular amount of Last year / Sales * 100