Question

You have just been hired as a financial analyst for Lydex Company, a manufacturer of safety helmets. Your boss has asked you to perform a comprehensive analysis of the company’s financial statements, including comparing Lydex’s performance to its major competitors. The company’s financial statements for the last two years are as follows:

Lydex Company Comparative Balance Sheet
	This Year		Last Year
Assets
Current assets:
Cash	$	920,000	$	1,160,000
Marketable securities		0		300,000
Accounts receivable, net		2,540,000		1,640,000
Inventory		3,560,000		2,100,000
Prepaid expenses		250,000		190,000
Total current assets		7,270,000		5,390,000
Plant and equipment, net		9,440,000		9,010,000
Total assets	$	16,710,000	$	14,400,000
Liabilities and Stockholders' Equity
Liabilities:
Current liabilities	$	3,970,000	$	2,900,000
Note payable, 10%		3,640,000		3,040,000
Total liabilities		7,610,000		5,940,000
Stockholders' equity:
Common stock, $75 par value		7,500,000		7,500,000
Retained earnings		1,600,000		960,000
Total stockholders' equity		9,100,000		8,460,000
Total liabilities and stockholders' equity	$	16,710,000	$	14,400,000

Lydex Company Comparative Income Statement and Reconciliation
	This Year		Last Year
Sales (all on account)	$	15,820,000	$	13,180,000
Cost of goods sold		12,656,000		9,885,000
Gross margin		3,164,000		3,295,000
Selling and administrative expenses		1,400,000		1,588,000
Net operating income		1,764,000		1,707,000
Interest expense		364,000		304,000
Net income before taxes		1,400,000		1,403,000
Income taxes (30%)		420,000		420,900
Net income		980,000		982,100
Common dividends		340,000		491,050
Net income retained		640,000		491,050
Beginning retained earnings		960,000		468,950
Ending retained earnings	$	1,600,000	$	960,000

To begin your assignment you gather the following financial data and ratios that are typical of companies in Lydex Company’s industry:

Current ratio	2.3
Acid-test ratio	1.1
Average collection period	40	days
Average sale period	60	days
Return on assets	8.8	%
Debt-to-equity ratio	0.7
Times interest earned ratio	5.8
Price-earnings ratio	10

Required:

1. You decide first to assess the company’s performance in terms of debt management and profitability. Compute the following for both this year and last year: (Round your "Percentage" answers to 1 decimal place and other answers to 2 decimal places.)

a. The times interest earned ratio.

b. The debt-to-equity ratio.

c. The gross margin percentage.

d. The return on total assets. (Total assets at the beginning of last year were $13,030,000.)

e. The return on equity. (Stockholders’ equity at the beginning of last year totaled $7,968,950. There has been no change in common stock over the last two years.)

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

Answer 1

f) Each industry has different debt to equity ratio benchmarks, as some industries tend to use more debt financing than others. A debt to equity ratio of 1 would mean that investors and creditors have an equal stake in the business assets.

A lower debt to equity ratio usually implies a more financially stable business. Companies with a higher debt to equity ratio are considered more risky to creditors and investors than companies with a lower ratio. Unlike equity financing, debt must be repaid to the lender. Since debt financing also requires debt servicing or regular interest payments, debt can be a far more expensive form of financing than equity financing. Companies leveraging large amounts of debt might not be able to make the payments.

Here in presence case Debt To Equity Ratio has increased form 0.70 to 0.84. which is not good indicator for company. It also effected Return On Equity , which decreased to 10.8% this year as compared to 11.6% last year. So company's financial leverage is negative.