Question

Pinnacle Plus declared and paid a cash dividend of $7,700 in the current year. Its comparative financial statements, prepared at December 31, reported the following summarized information:

	Current Year				Previous Year
Income Statement
Sales Revenue	$	165,000			$	143,000
Cost of Goods Sold		74,000				70,000
Gross Profit		91,000				73,000
Operating Expenses		47,000				41,800
Interest Expense		5,100				5,100
Income before Income Tax Expense		38,900				26,100
Income Tax Expense (30%)		11,670				7,830
Net Income	$	27,230			$	18,270
Balance Sheet
Cash	$	83,855			$	27,000
Accounts Receivable, Net		28,000				23,000
Inventory		36,000				49,000
Property and Equipment, Net		106,000				116,000
Total Assets	$	253,855			$	215,000
Accounts Payable	$	53,000			$	33,900
Income Tax Payable		1,275				1,050
Note Payable (long-term)		51,000				51,000
Total Liabilities		105,275				85,950
Common Stock (par $10)		96,600				96,600
Retained Earnings		51,980				32,450
Total Liabilities and Stockholders’ Equity	$	253,855			$	215,000

Required:

1. Compute the gross profit percentage in the current and previous years. Are the current year results better, or worse, than those for the previous year?
2. Compute the net profit margin for the current and previous years. Are the current year results better, or worse, than those for the previous year?
3. Compute the earnings per share for the current and previous years. Are the current year results better, or worse, than those for the previous year?
4. Stockholders’ equity totaled $111,000 at the beginning of the previous year. Compute the return on equity (ROE) ratios for the current and previous years. Are the current year results better, or worse, than those for the previous year?
5. Net property and equipment totaled $121,000 at the beginning of the previous year. Compute the fixed asset turnover ratios for the current and previous years. Are the current year results better, or worse, than those for the previous year?
6. Compute the debt-to-assets ratios for the current and previous years. Is debt providing financing for a larger or smaller proportion of the company’s asset growth?
7. Compute the times interest earned ratios for the current and previous years. Are the current year results better, or worse, than those for the previous year?
8. After Pinnacle Plus released its current year’s financial statements, the company’s stock was trading at $29. After the release of its previous year’s financial statements, the company’s stock price was $26 per share. Compute the P/E ratios for both years. Does it appear that investors have become more (or less) optimistic about Pinnacle’s future success?

Answer 1

Ration analysis is an important tool for financial statements analysis. It considers the relation of two variables in the financial statement.

1.
Computation of the gross profit percentage in the current and previous years.

Gross profit percentage = Gross profit /Sales revenue

Current Year:

Gross profit = 91,000
Sales Revenue = 165,000
Gross Profit Percentage = 91,000/165,000 = 55.2%

Previous Year:

Gross profit = 73,000
Sales Revenue= 143,000
Gross Profit Percentage = 73,000/143,000 = 51%

The current year results are better than those for the previous year, because the rate was 51% in the previous year and currently it is 55.2%

2.
Computation of the net profit margin for the current and previous years.

Net profit margin = Net income / Sales revenue

Current Year:

Net Income = 27,230
Sales Revenue = 165,000
Net Profit Margin = 16.5%

Previous Year:

Net Income = 18,270
Sales Revenue = 143,000
Net Profit Margin = 12.8%

The current year results are better than those for the previous year because current year it is in ready to 16.5% from 12.8% of the previous year.

3.
Computation of the earnings per share for the current and previous years.

Earnings per share = Net income / Outstanding Common stock

Current Year:

Net Income = 27,230
Outstanding Common Stock (96,600/10) = 9,660
Earnings per Share = 2.83

Previous Year:

Net Income = 18,270
Outstanding Common Stock (96,600/10) = 9,660
Earnings per Share = 1.89

The current year results are better than those for the previous year because it is increased to 2.83 in the current year from 1.89 in the previous year.

4.
Computation of the return on equity (ROE) ratios for the current and previous years.

Return on equity = Net income / Average equity

Current Year:

Average equity = [Beginning Equity + Ending Equity] ÷ 2
Beginning equity = 96,600 + 32,450 = 129,050
Ending equity = 96,600 + 51,980 = 148,580

Average equity = (129,050 + 148,580) / 2 = 138,815
Net Income = 27,230
Return on Equity = 27,230/ 138,815 = 19.6%

Previous Year:

Average equity = [Beginning Equity + Ending Equity] ÷ 2
Beginning equity = 111,000
Ending equity = 96,600 + 32,450 = 129,050

Average equity = (111,000 + 129,050) / 2 = 120,025
Net Income = 18,270
Return on Equity = 18,270/ 120,025 = 15.2%

The current year results are better than those for the previous year because of the increase in the current year from 15.2% to 19.6%

5.
Computation of the fixed asset turnover ratios for the current and previous years.

Fixed assets turn over ratio = Sales revenue / Average fixed assets

Current Year:

Average fixed assets = (Beginning Fixed Assets + Ending Fixed Assets) / 2
Beginning Fixed Assets = 116,000
Ending Fixed Assets = 106,000

Average fixed assets = (116,000 + 106,000) = 111,000
Sales Revenue = 165,000
Fixed Asset Turnover = 165,000/ 111,000 = 1.49 times

Previous Year:

Average fixed assets = (Beginning Fixed Assets + Ending Fixed Assets) / 2
Beginning Fixed Assets = 121,000
Ending Fixed Assets = 116,000

Average fixed assets = (121,000 + 116,000) / 2 = 118,500
Sales Revenue = 143,000
Fixed Asset Turnover = 143,000/ 118,500 = 1.21 times

The current year results are better than those for the previous year.

6.
Computation of the debt-to-assets ratios for the current and previous years.

Debt to asset ratio = Total liabilities / Total assets

Current Year:

Total Liabilities = 105,275
Total Assets = 253,855
Debt to Assets Ratio = 105,275/253,855 = 41.5%

Previous Year:

Total Liabilities = 85,950
Total Assets = 215,000
Debt to Assets Ratio = 85,950 / 215,000 = 40%

The debt is providing financing for a larger of the company's asset growth.

7.
Computation of the times interest earned ratios for the current and previous years.

Times interest earned ratio = Net income/ Interest expense

Current Year:

Net Income = 27,230
Interest Expense = 5,100
Time Interest Earned = 27,230 / 5,100 = 5.34 times

Previous Year:

Net Income = 18,270
Interest Expense = 5,100
Time Interest Earned = 3.58 times

The current year results are better than those for the previous year.

8.
Computation of the P/E ratios for both years.

P/E ratio = Share price/ Earnings per share

Current Year:

Price= 29
Earnings per Share = 2.83
Price Earnings Ratio = 29/ 2.83 = 10.25

Previous Year:

Price = 26
Earnings per Share = 1.89
Price Earnings Ratio = 26/ 1.89 = 13.76

It does appear that investors have become more optimistic about Pinnacle's future success.