Question

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 $620,000 long-term loan from Gulfport State Bank, $160,000 of which will be used to bolster the Cash account and $460,000 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 $ 118,000 $ 270,000      Marketable securities 0 30,000      Accounts receivable, net 633,000 420,000      Inventory 1,065,000 715,000      Prepaid expenses 30,000 34,000         Total current assets 1,846,000 1,469,000      Plant and equipment, net 1,969,200 1,490,000         Total assets $ 3,815,200 $ 2,959,000         Liabilities and Stockholders Equity      Liabilities:      Current liabilities $ 820,000 $ 420,000      Bonds payable, 12% 850,000 850,000         Total liabilities 1,670,000 1,270,000         Stockholders' equity:      Common stock, $15 par 810,000 810,000      Retained earnings 1,335,200 879,000         Total stockholders’ equity 2,145,200 1,689,000         Total liabilities and equity $ 3,815,200 $ 2,959,000       Sabin Electronics Comparative Income Statement and Reconciliation This Year Last Year   Sales $ 5,600,000 $ 4,710,000      Cost of goods sold 3,995,000 3,570,000         Gross margin 1,605,000 1,140,000      Selling and administrative expenses 677,000 572,000         Net operating income 928,000 568,000      Interest expense 102,000 102,000         Net income before taxes 826,000 466,000      Income taxes (30%) 247,800 139,800         Net income 578,200 326,200      Common dividends 122,000 101,000         Net income retained 456,200 225,200      Beginning retained earnings 879,000 653,800         Ending retained earnings $ 1,335,200 $ 879,000       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 2/10, n/30. All sales are on account.      Assume that Paul Sabin has asked you to assess his company’s profitability and stock market performance. 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. (Round your percentage answers to 1 decimal place (i.e., 0.1234 should be entered as 12.3).)

           

b.	The net profit margin percentage. (Round your percentage answers to 1 decimal place (i.e., 0.1234 should be entered as 12.3).)

           

c.	The return on total assets. (Total assets at the beginning of last year were $2,919,000.) (Round your percentage answers to 1 decimal place (i.e., 0.1234 should be entered as 12.3).)

           

d.	The return on equity. (Stockholders’ equity at the beginning of last year was $1,679,000.) (Round your percentage answers to 1 decimal place (i.e., 0.1234 should be entered as 12.3).)

             

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

Answer 1

Answer of Part a:

For This Year:

Gross Margin Percentage = Gross Margin / Net Sales *100
Gross Margin Percentage = $1,605,000 / $5,600,000 *100
Gross Margin Percentage = 28.7%

For Last Year:

Gross Margin Percentage = Gross Margin / Net Sales *100
Gross Margin Percentage = $1,140,000 / $4,710,000 *100
Gross Margin Percentage = 24.2%

Answer of Part b:

For This Year:

Net Profit Margin = Net Income / Net Sales *100
Net Profit Margin = $578,200 / $5,600,000 *100
Net Profit Margin = 10.3%

For Last Year:

Net Profit Margin = Net Income / Net Sales *100
Net Profit Margin = $326,200 / $4,710,000
Net Profit Margin = 7%

Answer of Part c:

For This Year:

Average Total Assets = (Beginning Total Assets + Ending Total Assets) /2
Average Total Assets = ($2,959,000 + $3,815,200) /2
Average Total Assets = $3,387,100

Return on Total Assets = Net Income / Average Total Assets
Return on Total Assets = $578,200 / $3,387,100
Return on Total Assets = 17.1

For Last Year:

Average Total Assets = (Beginning Total Assets + Ending Total Assets) /2
Average Total Assets = ($2,919,000 + $2,959,000) /2
Average Total Assets = $2,939,000

Return on Total Assets = Net Income / Average Total Assets
Return on Total Assets = $326,200 / $2,939,000
Return on Total Assets = 11.1%

Answer of Part d:

For This Year:

Average stockholders’ Equity = (Beginning stockholders Equity + Ending stockholders Equity) /2
Average Stockholders Equity = ($1,689,000 + $2,145,200) /2
Average Stockholders Equity = $1,917,100

Return on Equity = Net Income / Average Stockholders Equity
Return on Equity = $578,200 / $1,917,100
Return on Equity = 30.2%

For Last Year:

Average stockholders’ Equity = (Beginning stockholders Equity + Ending stockholders Equity) /2
Average Stockholders Equity = ($1,679,000 + $1,689,000) /2
Average Stockholders Equity = $1,684,000

Return on Equity = Net Income / Average Stockholders Equity
Return on Equity = $326,200 / $1,684,000
Return on Equity = 19.4%