Question

You have just been hired as a financial analyst for Lydex Company, a manufacturer of safety helmets. Your boss has asked you to perform a comprehensive analysis of the company’s financial statements, including comparing Lydex’s performance to its major competitors. The company’s financial statements for the last two years are as follows:

Lydex Company Comparative Balance Sheet
	This Year		Last Year
Assets
Current assets:
Cash	$	980,000	$	1,220,000
Marketable securities		0		300,000
Accounts receivable, net		2,780,000		1,880,000
Inventory		3,620,000		2,200,000
Prepaid expenses		260,000		200,000
Total current assets		7,640,000		5,800,000
Plant and equipment, net		9,560,000		9,070,000
Total assets	$	17,200,000	$	14,870,000
Liabilities and Stockholders' Equity
Liabilities:
Current liabilities	$	4,030,000	$	3,020,000
Note payable, 10%		3,680,000		3,080,000
Total liabilities		7,710,000		6,100,000
Stockholders' equity:
Common stock, $75 par value		7,500,000		7,500,000
Retained earnings		1,990,000		1,270,000
Total stockholders' equity		9,490,000		8,770,000
Total liabilities and stockholders' equity	$	17,200,000	$	14,870,000

Lydex Company Comparative Income Statement and Reconciliation
	This Year		Last Year
Sales (all on account)	$	15,880,000	$	13,780,000
Cost of goods sold		12,704,000		10,335,000
Gross margin		3,176,000		3,445,000
Selling and administrative expenses		1,208,000		1,612,000
Net operating income		1,968,000		1,833,000
Interest expense		368,000		308,000
Net income before taxes		1,600,000		1,525,000
Income taxes (30%)		480,000		457,500
Net income		1,120,000		1,067,500
Common dividends		400,000		533,750
Net income retained		720,000		533,750
Beginning retained earnings		1,270,000		736,250
Ending retained earnings	$	1,990,000	$	1,270,000

To begin your assignment you gather the following financial data and ratios that are typical of companies in Lydex Company’s industry:

Current ratio	2.4
Acid-test ratio	1.1
Average collection period	32	days
Average sale period	60	days
Return on assets	9.5	%
Debt-to-equity ratio	0.7
Times interest earned ratio	5.8
Price-earnings ratio	10
3. You decide, finally, to assess the company’s liquidity and asset management. For both this year and last year, compute: a. Working capital. b. The current ratio. (Round your final answers to 2 decimal places.) c. The acid-test ratio. (Round your final answers to 2 decimal places.) d. The average collection period. (The accounts receivable at the beginning of last year totaled $1,690,000.) (Use 365 days in a year. Round your intermediate calculations and final answer to 2 decimal place.) e. The average sale period. (The inventory at the beginning of last year totaled $2,050,000.) (Use 365 days in a year. Round your intermediate calculations and final answer to 2 decimal place.) f. The operating cycle. (Round your intermediate calculations and final answer to 2 decimal place.) g. The total asset turnover. (The total assets at the beginning of last year totaled $14,630,000.) (Round your final answers to 2 decimal places.)

Answer 1

Answer a.

This Year:

Working Capital = Current Assets - Current Liabilities
Working Capital = $7,640,000 - $4,030,000
Working Capital = $3,610,000

Last Year:

Working Capital = Current Assets - Current Liabilities
Working Capital = $5,800,000 - $3,020,000
Working Capital = $2,780,000

Answer b.

This Year:

Current Ratio = Current Assets / Current Liabilities
Current Ratio = $7,640,000 / $4,030,000
Current Ratio = 1.90

Last Year:

Current Ratio = Current Assets / Current Liabilities
Current Ratio = $5,800,000 / $3,020,000
Current Ratio = 1.92

Answer c.

This Year:

Acid-test Ratio = (Current Assets - Inventory - Prepaid Expenses) / Current Liabilities
Acid-test Ratio = ($7,640,000 - $3,620,000 - $260,000) / $4,030,000
Acid-test Ratio = 0.93

Last Year:

Acid-test Ratio = (Current Assets - Inventory - Prepaid Expenses) / Current Liabilities
Acid-test Ratio = ($5,800,000 - $2,200,000 - $200,000) / $3,020,000
Acid-test Ratio = 1.13

Answer d.

This Year:

Average Accounts Receivable = ($2,780,000 + $1,880,000) / 2
Average Accounts Receivable = $2,330,000

Average Collection Period = 365 * Average Accounts Receivable / Sales
Average Collection Period = 365 * $2,330,000 / $15,880,000
Average Collection Period = 53.55 days

Last Year:

Average Accounts Receivable = ($1,880,000 + $1,690,000) / 2
Average Accounts Receivable = $1,785,000

Average Collection Period = 365 * Average Accounts Receivable / Sales
Average Collection Period = 365 * $1,785,000 / $13,780,000
Average Collection Period = 47.28 days