Question

Pinnacle Plus declared and paid a cash dividend of $6,600 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	$	110,000			$	99,000
Cost of Goods Sold		52,000				48,000
Gross Profit		58,000				51,000
Operating Expenses		36,000				33,000
Interest Expense		4,000				4,000
Income before Income Tax Expense		18,000				14,000
Income Tax Expense (30%)		5,400				4,200
Net Income	$	12,600			$	9,800
Balance Sheet
Cash	$	69,500			$	38,000
Accounts Receivable, Net		17,000				12,000
Inventory		25,000				38,000
Property and Equipment, Net		95,000				105,000
Total Assets	$	206,500			$	193,000
Accounts Payable	$	42,000			$	35,000
Income Tax Payable		1,000				500
Note Payable (long-term)		40,000				40,000
Total Liabilities		83,000				75,500
Common Stock (par $10)		90,000				90,000
Retained Earnings		33,500				27,500
Total Liabilities and Stockholders’ Equity	$	206,500			$	193,000

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 $100,000 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 $110,000 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 $18. After the release of its previous year’s financial statements, the company’s stock price was $15 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

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?

Gross Profit Margin = (Gross profit margin / sales)*100

Current year = ($58,000 / $110,000)*100 = 52.72%

Previous Year = (51,000 / $99,000)*100 = 51.51%

Current year Gross profit margin is more than the previous year so it is better than 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?

Net Profit = (Net Profit / Sales)*100

Current Year = ($12,600 / $110,000)*100 = 11.45%

Previous Year = ($9,800 / $99,000)*100 = 9.89%

Current year Net profit margin is more than the previous year so it is better than 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?

Earnings per share = Net Income / shares Outstanding

Calculation of shares outstanding

Shares outstanding = Value of Common Stock / Common stock price per share

Both for Current Year and previous year = $90,000 / $10 = 9,000 shares

Earnings per share

Current Year = $12,600 / 9,000 = $1.4

Previous Year = $9,800 / 9,000 = $1.08

Current year Earnings Per Share is more than the previous year so it is better than previous year.

4) Stockholders’ equity totaled $100,000 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?

Return on equity = Net Income / Average Share holder's equity

Average share Holder's equity =(Beginning shareholder's equity + Ending shareholder's equity)/2

Average Share holder's equity

Current Year = ($90,000 + $90,000) / 2 = $90,000

Previous Year = ($100,000 +$90,000) / 2 = $95,000

Return on Equity

Current Year = $12,600 / $90,000 = 0.14

Previous Year = $9,800 / $95,000 = 0.10

Current year Return on Equity is more than the previous year so it is better than previous year.

5) Net property and equipment totaled $110,000 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?

Fixed Asset Turnover Ratio = Net sales / Average Total Fixed Assets

Average Total Fixed Assets = (Beginning Total Fixed Assets / Ending Total Fixed Assets)/2

Average Total Assets

Current Year = ($105,000 + $95,000) / 2 = $100,000

Previous Year = ($110,000 + $105,000) / 2 = $107,500

Fixed Asset Turnover Ratio

Current Year = $110,000 / $100,000 = 1.1

Previous Year = $99,000 / $107,500 = 0.92

Current results of Fixed Asset Turnover Ratio is better than the Previous year as the ratio of current year is more than 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?

Debt to Assets Ratio = Total Debt / Total Assets

Current Year = $83,000 / $206,500 = 0.40

Previous Year = $75,500 / $193,000 = 0.39

When compared to previous year current years debt is providing financing larger portion of the company's assets.

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?

Times Interest Expense = EBIT / Total Interest Expense

Total Interest Expense = EBIT + Income Taxes + Interest Expense

Total Interest Expense

Current year = $12,600 + $5,400 + $4,000 = $22,000

Previous Year = $9,800 + $4,200 + $4,000 = $18,000

Times Interest Expense

Current Year = $22,000 / $4,000 = 5.5

Previous Year = $18,000 / $4,000 = 4.5

Current year results are better tha pprevious years results as it is able to pay 5.5 times while previous year it is able to pay only 4.5 times. Current year has the more ability to pay interest

8) After Pinnacle Plus released its current year’s financial statements, the company’s stock was trading at $18. After the release of its previous year’s financial statements, the company’s stock price was $15 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?

Price earning Ratio = Market Price Per Share / Earnings per share.

We have already calculated earnings per share which are $1.4 for current year and $1.08 for previous year

Price Earning Ratio

Current Year = $18 / $1.4 = 12.85

Previous Year = $15 / $1.08 = 13.88

The Price earninge ratio has decreased from previous year to current year., it means the investors became less optimistic about Pinnacle's future success