Question

You have just been hired as a loan officer at San Diego State Bank. Your supervisor has given you a file containing a request from Mobile Company, a manufacturer of auto components, for a $1,000,000 five-year loan. Financial statement data on the company for the last two years are given below:

Mobile Company
Comparative Balance Sheet
	This Year		Last Year
Assets
Current assets:
Cash	$	278,500	$	355,750
Marketable securities		0		114,000
Accounts receivable, net		934,000		637,000
Inventory		1,352,500		752,500
Prepaid expenses		98,500		83,500
Total current assets		2,663,500		1,942,750
Plant and equipment, net		3,450,800		3,106,400
Total assets	$	6,114,300	$	5,049,150
Liabilities and Stockholders’ Equity
Liabilities:
Current liabilities	$	1,274,000	$	762,000
Bonds payable		1,310,000		1,110,000
Total liabilities		2,584,000		1,872,000
Stockholders' equity:
Preferred stock, 8%, $30 par value		600,000		600,000
Common stock, $40 par value		2,000,000		2,000,000
Retained earnings		930,300		577,150
Total stockholders' equity		3,530,300		3,177,150
Total liabilities and stockholders' equity	$	6,114,300	$	5,049,150

Mobile Company
Comparative Income Statement and Reconciliation
	This Year		Last Year
Sales	$	5,490,000	$	4,310,000
Cost of goods sold		4,115,000		3,205,000
Gross margin		1,375,000		1,105,000
Selling and administrative expenses		545,000		525,000
Net operating income		830,000		580,000
Interest expense		135,500		115,500
Net income before taxes		694,500		464,500
Income taxes (30%)		208,350		139,350
Net income		486,150		325,150
Dividends paid:
Preferred stock		48,000		48,000
Common stock		85,000		61,000
Total dividends paid		133,000		109,000
Net income retained		353,150		216,150
Retained earnings, beginning of year		577,150		361,000
Retained earnings, end of year	$	930,300	$	577,150

Loretta Young, who just two years ago was appointed president of Mobile Company, admits that the company has been “inconsistent” in its performance over the past several years. But Young argues that the company has its costs under control and is now experiencing strong sales growth, as evidenced by the more than 27% increase in sales over the last year. Young also argues that investors have recognized the improving situation at Mobile Company, as shown by the jump in the price of its common stock from $47.00 per share last year to $57.00 per share this year. Young believes that with strong leadership and with the modernized equipment that the $1,000,000 loan will enable the company to buy, profits will be even stronger in the future.

Anxious to impress your supervisor, you decide to generate all the information you can about the company. You determine that the following ratios are typical of companies in Mobile’s industry:

Current ratio	2.3
Acid-test ratio	1.2
Average collection period	31	days
Average sale period	60	days
Return on assets	9.5	%
Debt-to-equity ratio	0.65
Times interest earned	5.7
Price-earnings ratio	10

    

Required:

1.	You decide first to assess the rate of return that the company is generating. Compute the following for both this year and last year:

a.	The return on total assets. (Total assets at the beginning of last year were $4,390,000.) (Round your percentage answers to 1 decimal place i.e., 0.123 is considered as 12.3.)

b.	The return on common stockholders’ equity. (Stockholders' equity at the beginning of last year totaled $4,519,185. There has been no change in preferred or common stock over the last two years.) (Do not round your intermediate calculations. Round your percentage answers to 1 decimal place i.e., 0.123 is considered as 12.3.)

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

  

2.	You decide next to assess the well-being of the common stockholders. For both this year and last year, compute:

a.	The earnings per share. (Round your answers to 2 decimal places.)

b.	The dividend yield ratio for common stock. (Round your intermediate calculations to 2 decimal places and and your percentage answers to 1 decimal place i.e., 0.123 is considered as 12.3.)

c.	The dividend payout ratio for common stock. (Round your intermediate calculations to 2 decimal places and your percentage answers to 1 decimal place i.e., 0.123 is considered as 12.3.)

d.	The price-earnings ratio. (Round your intermediate calculations to 2 decimal places and final answers to 1 decimal place.)

e.	The book value per share of common stock. (Round your answers to 2 decimal places.)

f.	The gross margin percentage. (Round your percentage answers to 1 decimal place i.e., 0.123 is considered as 12.3.)

3.	You decide, finally, to assess creditor ratios to determine both short-term and long-term debt paying ability. For both this year and last year, compute:

a.	Working capital.

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

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

d.	The average collection period. (The accounts receivable at the beginning of last year totaled $520,000.) (Use 365 days in a year. Do not round intermediate calculations. Round your final answers to the nearest whole number.)

e.	The average sale period. (The inventory at the beginning of last year totaled $650,000.) (Use 365 days in a year. Round your intermediate calculations to 2 decimal and final answers to the nearest whole number.)

f.	The debt-to-equity ratio. (Round your answers to 2 decimal places.)

g.	The times interest earned. (Round your answers to 1 decimal place.)

Answer 1

Part 1:
	This year	Last year
Return on total assets
Net income	486150	325150
Average total assets
Opening assets	5049150	4390000
Add: Closing total assets	6114300	5049150
	11163450	9439150
Average total assets (opening assets + closing assets) / 2	5581725	4719575
Return on total assets (Net income x 100/ Average total assets )	8.7096731	6.889392
b. The return on common shareholders' equity
Net income	486150	325150
Less: Preferred dividend	48000	48000
Earnings available to the common shareholders	438150	277150
Average common share holders' equity
Opening common shareholders' equity	3177150	4519185
Add: Closing common shareholders' equity	3530300	3177150
	6707450	7696335
Average common share holders' equity (Opening equity + closing equity) /2	3353725	3848168
b. The return on common shareholders' equity (Earnings available to common shareholders x 100/ Average equity)	13.064577	7.202129
c. Degree of financial leverage
Net income before interest and taxes	830000	580000
Net income before taxes	694500	464500
Degree of financial leverage (EBIT / EBIT - Interest)	1.1951044	1.248654
Yes, company's financial leverage is positive

Part 2:
	This year	Last year
a. Earnings per share
Net income	486150	325150
Less: Preferred dividend	48000	48000
(A): Earnings available to the common shareholders	438150	277150
(B): Number of common shares	50000	50000
(2000000 / 40)
EPS (A/ B)	8.763	5.543
b. Dividend yield ratio for common stock
(A): Dividend paid to common shareholders	85000	61000
Average common share holders' equity
Opening common shareholders' equity	3177150	4519185
Add: Closing common shareholders' equity	3530300	3177150
	6707450	7696335
(B): Average common share holders' equity (Opening equity + closing equity) /2	3353725	3848168
Dividend yield (A x 100/B)	2.5344952	1.58517
c. Dividend pay-out ratio for common stock
(A): Dividend paid to common shareholders	85000	61000
Net income	486150	325150
Less: Preferred dividend	48000	48000
(B): Earnings available to the common shareholders	438150	277150
Dividend pay-out ratio for common stock (A x 100/B)	19.399749	22.00974
d. Price earnings ratio
(A): Market price per share	57	47
(B): EPS
EPS	8.763	5.543
Price earnings ratio (A/B)	6.5046217	8.479163
e. The books value of per share of common stock
(A): Common stockholders' equity	3530300	3177150
(B): Number of common shares	50000	50000
Book value per share (A/B)	70.606	63.543
f. The gross margin percentage
(A): Turnover / sales	5490000	4310000
(B): Gross profit	1375000	1105000
Gross margin percentage (B X 100 / A)	25.045537	25.63805

Part 3:
	This year	Last year
a. Working capital (Current assets - Current liabilities)
Total current assets	2663500	1942750
Less: Total current liabilities	1274000	762000
Working capital	1389500	1180750
b. Current ratio
Current assets	2663500	1942750
Current liabilities	1274000	762000
Current ratio (CA/CL)	2.0906593	2.549541
c. Acid test ratio
Current assets	2663500	1942750
Less: inventories	1352500	752500
(A): Current assets less inventories	1311000	1190250
(B): Current liabilities	1274000	762000
Acid test ratio (A/B)	1.0290424	1.562008
d. The average collection period (AR 520000)
Average accounts receivable:
Opening accounts receivable	637000	520000
Add: Closing accounts receivable	934000	637000
Opening plus closing accounts receivable	1571000	1157000
(A):Average accounts receivable:	785500	578500
(B): Sales	5490000	4310000
Average collection period in days (A x 365 /B)	52.223588	48.9913
e. Average sales period with inventory 650000
Average inventory:
Opening inventory	752500	650000
Add: Closing inventory	1352500	752500
	2105000	1402500
(A): Average inventory (Opening plus closing inventory / 2)	1052500	701250
(B): Sales	5490000	4310000
e. Average sales period with inventory (A x 365/B)	69.974954	59.3866
Debt to equity
(A): Debt fund	1310000	1110000
(B): Equity funds	3530300	3177150
Debt to equity (A/B)	0.3710733	0.34937
g. The times interest earned
Net income	486150	325150
Add: Interest expense	135500	115500
(A): Net income plus interest	621650	440650
(B): Interest expenses	135500	115500
The times interest earned (A/B)	4.5878229	3.815152