Question

Based on the following data, compute:

a) Current Ratio (Industry Average is 2.4)

b) Quick Ratio (Industry Average is 1.5)

c) Inventory Turnover (Industry Average is 100 days)

d) Accounts Receivable Turnover (Industry Average is 59 days)

e) Earnings Per Share (Industry Average is $2)

f) Price-Earnings Ratio (Industry Average is 5)

Data:

Cash = $91,000

A/R = $45,000

A/P = $99,000

Supplies = $1000

Equipment = $400,000

Wages Payable = $6000

Inventory = $110,000

Net Credit Sales = $600,000\

Cost of Goods Sold = $220,000

Average Common Shares = 500,000

Net Income = $1,200,000

Market Price Per Share = $9

Mortgage Payable = $100,000

Preferred Dividends = $50,000

Note: Explain the meaning behind your answers. Be sure to compare to industry averages

Answer 1

a) Current ratio:

Current ratio = Current Assets/Current Liabilities

Current assets = Cash+A/R+Supplies+Inventory

= 91,000+45,000+1000+110,000

= 247,000

Current Liability = A/P+wages payable

= 99,000+6000

= 105,000

(SINCE no information is given whether mortgage payments is due for 1 year or after 1 year hence it is assumed that it is due after 1 year an hence it is treated as non current liability)

Current ratio = 247,000/105,000

= 2.35

Explanation:

If the current ratio is lower than industry average then it is considered as risky. Hence in the given case current ratio (2.35) is lower than industry average (2.4) hence it is risky.

2) Quick ratio

Quick ratio = Current Assets-Inventory/Current Liabilities

= 247,000-110,000/105,000

= 137,000/105,000

= 1.30

Explanation :

If quick ratio is lower than the industry average then the company has lower liquidity compared to its competitors. Hence in the given case, quick ratio (1.3) is lower than industry average (1.5) and hence it is less liquid.

3) Inventort Turnover ratio

Inventory turnover ratio = Cost of goods sold/inventory*100

= 220,000/110,000*100

= 200 days

Explanation:

A lower inventory turnover ratio means weak sales and it creates excess inventory which leads to over stocking.Here inventory turnover ratio (200 days) is higher than industry average of 100 days and hence it is good sales.

4) Accounts receivable turnover:

Accounts Receivable Turnover = Net credit sales/Accounts receivable

= 600,000/45000

= 13 days

Explanation:

A lower accounts receivable ratio indicates the company has a poor collection policy and company should reassess the credit policies to ensure timely collection of receivables. Here the accounts receivable ratio (13 days) is lower than industry average (59 days) and hence it has poor collection policy of receivables.

5) Earnings per share:

Earning per share = Net Income/ Average shares Outstanding

Net income = Net income preferred dividends

= 1200,000-50,000 = 1150,000

= 1150,000/500,000

= 2.3

Explanation:

Higher earning per share indicates the higher earnings and strong financial position and it also increases the reliability of investors. Here the earning per share (2.4) is higher than industry average (2) and hence it has strong financial position.

6) Price earning ratio (P/E):

P/E ratio = market price per share(MPS)/Earning per share (EPS)

= 9/2.3

= 3.91

Explanation:

If P/E ratio lower than industry average indicates stock may be undervalued. Here P/E ratio (3.91) is lower than industry average (5) and hence it is undervalued.