Question

14.2

Paul Sabin organized Sabin Electronics 10 years ago 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 $640,000 long-term loan from Gulfport State Bank, $170,000 of which will be used to bolster the Cash account and $470,000 of which will be used to modernize 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	$	126,000	$	290,000
Marketable securities		0		11,000
Accounts receivable, net		659,000		440,000
Inventory		1,020,000		735,000
Prepaid expenses		34,000		36,000
Total current assets		1,839,000		1,512,000
Plant and equipment, net		2,084,600		1,470,000
Total assets	$	3,923,600	$	2,982,000
Liabilities and Stockholders Equity
Liabilities:
Current liabilities	$	870,000	$	440,000
Bonds payable, 12%		800,000		800,000
Total liabilities		1,670,000		1,240,000
Stockholders' equity:
Common stock, $20 par		830,000		830,000
Retained earnings		1,423,600		912,000
Total stockholders’ equity		2,253,600		1,742,000
Total liabilities and stockholders' equity	$	3,923,600	$	2,982,000

Sabin Electronics
Comparative Income Statement and Reconciliation
	This Year		Last Year
Sales	$	5,700,000	$	4,770,000
Cost of goods sold		4,015,000		3,590,000
Gross margin		1,685,000		1,180,000
Selling and administrative expenses		681,000		576,000
Net operating income		1,004,000		604,000
Interest expense		96,000		96,000
Net income before taxes		908,000		508,000
Income taxes (30%)		272,400		152,400
Net income		635,600		355,600
Common dividends		124,000		103,000
Net income retained		511,600		252,600
Beginning retained earnings		912,000		659,400
Ending retained earnings	$	1,423,600	$	912,000

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 3/10, n/30. All sales are on account.

Assume Paul Sabin has asked you to assess his company’s profitability and stock market performance.

Required:

1. You decide first to assess the company’s stock market performance. For both this year and last year, compute:

a. The earnings per share. There has been no change in common stock over the last two years.

b. The dividend yield ratio. The company’s stock is currently selling for $60 per share; last year it sold for $55 per share.

c. The dividend payout ratio.

d. The price-earnings ratio. (Assume that the industry norm for the price-earnings ratio is 7)

e. The book value per share of common stock.

2. You decide next to assess the company’s profitability. Compute the following for both this year and last year:

a. The gross margin percentage.

b. The net profit margin percentage.

c. The return on total assets. (Total assets at the beginning of last year were $2,942,000.)

d. The return on equity. (Stockholders’ equity at the beginning of last year was $1,732,000.)

e. Is the company’s financial leverage positive or negative?

Answer 1

Answer with working notes is given below