Question

Shown below are selected data from the financial statements of planet Company, a retain lighting store.

From the Balance Sheet:

Cash................................................................................................... $ 40,000

Accounts receivable........................................................................... 165,000

Inventory............................................................................................ 215,000

Plant assets (net of accumulated depreciation).................................. 600,000

Current liabilities............................................................................... 185,000

Total stockholders’ equity................................................................. 400,000

Total assets........................................................................................ 1,200,000

From the Income Statement:

Net sales............................................................................................. $2,000,000

Cost of goods sold............................................................................. 1,600,000

Operating expenses............................................................................ 300,000

Interest expense................................................................................. 75,000

Income taxes expense........................................................................ 5,000

Net income......................................................................................... 20,000

From the Statement of Cash Flows:

Net cash provided by operating activities

(including interest paid of $68,000)............................................... $ 42,000

Net cash used in investing activities.................................................. (49,000)

Financing activities:

Amounts borrowed................................................. $ 60,000

Repayment of amounts borrowed........................... (20,000)

Dividends paid........................................................ (25,000)

Net cash provided by financing activities................................... 15,000

Net increase in cash during the year.................................................. $ 8,000

Required:

1. Explain how the interest expense shown in the income statement could be $75,000, when the interest payment appearing in the statement of cash flows is only $68,000.
2. Work out the following (round to one decimal place):
   1. Current ratio
   2. Quick ratio
   3. Working capital
   4. Debt ratio
3. Comment on these measurements and evaluate Planet’s short-term debit-paying ability.
4. Compute the following ratios (assume that the year-end amounts of total assets and total stockholders’ equity also represent the average amounts throughout the year):
   1. Return on assets
   2. Return on equity
5. Comment on the company’s performance under these measurements. Sufficiently explain why the return on assets and return on equity are so different.
6. Discuss (i) the apparent safety of long-term creditors’ claims and (ii) the prospects for Planet Co. continuing its dividend payments at the present level.

Answer 1

The detailed answer for the above question is provided below:

 

a.   Interest expense is based on the accrual concept whereas the cash flow statement records the expenses based on cash expense only. 

 

b.   Current ratio= Current assets/current liabilities

                          = 420000/185000   = 2.270

      Quick ratio= current assets-inventory/current liabilities

                       = 1.108

      Working capital= Current assets- current liabilities

                              = 420000-185000  = 235000

      Debt ratio= Total debts/Total assets

                     = 185000/1200000= 0.154

 

c. Higher current ratio or quick ratio indicates better liquidity for the company. 

 

d. Return on assets= Net income /Total assets  

                               = 20000/1200000   =  1.667

   Return on equity= Net income /Shareholder's Equity

                             = 20000/400000   = 5