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	$	880,000	$	1,120,000
Marketable securities		0		300,000
Accounts receivable, net		2,380,000		1,480,000
Inventory		3,520,000		2,200,000
Prepaid expenses		240,000		180,000
Total current assets		7,020,000		5,280,000
Plant and equipment, net		9,360,000		8,970,000
Total assets	$	16,380,000	$	14,250,000
Liabilities and Stockholders' Equity
Liabilities:
Current liabilities	$	3,930,000	$	2,820,000
Note payable, 10%		3,620,000		3,020,000
Total liabilities		7,550,000		5,840,000
Stockholders' equity:
Common stock, $75 par value		7,500,000		7,500,000
Retained earnings		1,330,000		910,000
Total stockholders' equity		8,830,000		8,410,000
Total liabilities and stockholders' equity	$	16,380,000	$	14,250,000

Lydex Company Comparative Income Statement and Reconciliation
	This Year		Last Year
Sales (all on account)	$	15,780,000	$	12,780,000
Cost of goods sold		12,624,000		9,585,000
Gross margin		3,156,000		3,195,000
Selling and administrative expenses		1,794,000		1,572,000
Net operating income		1,362,000		1,623,000
Interest expense		362,000		302,000
Net income before taxes		1,000,000		1,321,000
Income taxes (30%)		300,000		396,300
Net income		700,000		924,700
Common dividends		280,000		462,350
Net income retained		420,000		462,350
Beginning retained earnings		910,000		447,650
Ending retained earnings	$	1,330,000	$	910,000

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	1.0
Average collection period	30	days
Average sale period	60	days
Return on assets	8.4	%
Debt-to-equity ratio	0.7
Times interest earned ratio	5.7
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 $12,990,000.)

e. The return on equity. (Stockholders’ equity at the beginning of last year totaled $7,947,650. There has been no change in common stock over the last two years.)

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

2. You decide next to assess the company’s stock market performance. Assume that Lydex’s stock price at the end of this year is $78 per share and that at the end of last year it was $46. For both this year and last year, compute: (Round your "Percentage" answers to 1 decimal place and other intermediate and final answers to 2 decimal places.)

a. The earnings per share.

b. The dividend yield ratio.

c. The dividend payout ratio.

d. The price-earnings ratio.

e. The book value per share of common stock.

3. You decide, finally, to assess the company’s liquidity and asset management. For both this year and last year, compute:

a. Working capital.

b. The current ratio. (Round your final answers to 2 decimal places.)

c. The acid-test ratio. (Round your final answers to 2 decimal places.)

d. The average collection period. (The accounts receivable at the beginning of last year totaled $1,590,000.) (Use 365 days in a year. Round your intermediate calculations and final answer to 2 decimal place.)

e. The average sale period. (The inventory at the beginning of last year totaled $1,950,000.) (Use 365 days in a year. Round your intermediate calculations and final answer to 2 decimal place.)

f. The operating cycle. (Round your intermediate calculations and final answer to 2 decimal place.)

g. The total asset turnover. (The total assets at the beginning of last year totaled $14,530,000.) (Round your final answers to 2 decimal places.)

1. Present the balance sheet in common-size format.

2. Present the income statement in common-size format down through net income.

Answer 1

1) a) This Year

Times Interest Earned Ratio = Earning Before Interest and Tax/Interest Expense

Earning Before Interest and Tax in the given income statement is equal to net operating income.

Times Interest Earned Ratio = $1,362,000/$362,000 = 3.76

Last Year

Times Interest Earned Ratio = Earning Before Interest and Tax/Interest Expense

Times Interest Earned Ratio = $1,623,000/$302,000 = 5.37

b) This Year

Debt to Equity Ratio = Total Liabilities/Stockholder's Equity

= $7,550,000/$8,830,000 = 0.86

Last Year

Debt to Equity Ratio = Total Liabilities/Stockholder's Equity

= $5,840,000/$8,410,000 = 0.69

c) This Year

Gross Margin Percentage = Gross Margin/Sales

= $3,156,000/$15,780,000 = 0.20 or 20%

Last Year

Gross Margin Percentage = Gross Margin/Sales

= $3,195,000/$12,780,000 = 0.25 or 25%

d) This Year

Return on Total Assets = Earning before Interest and tax/Average Total Assets

Average Total Assets = (Total Assets This Year+Total Assets Last Year)/2

= ($16,380,000+$14,250,000)/2 = $15,315,000

Return on Total Assets = $1,362,000/$15,315,000 = 8.9%

(Earning before interest and tax is equal to net operating income given in the income statement)

Last Year

Return on Total Assets = Earning before Interest and tax/Average Total Assets

Average Total Assets = (Total Assets Last Year End+Total Assets Last Year Beginning)/2

= ($14,250,000+$12,990,000)/2 = $13,620,000

Return on Total Assets = $1,623,000/$13,620,000 = 11.9%