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 $570,000 long-term loan from Gulfport State Bank, $135,000 of which will be used to bolster the Cash account and $435,000 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	$	98,000	$	220,000
Marketable securities		0		25,000
Accounts receivable, net		568,000		370,000
Inventory		1,015,000		665,000
Prepaid expenses		26,000		29,000
Total current assets		1,707,000		1,309,000
Plant and equipment, net		1,686,200		1,400,000
Total assets	$	3,393,200	$	2,709,000
Liabilities and Stockholders Equity
Liabilities:
Current liabilities	$	835,000	$	500,000
Bonds payable, 12%		600,000		600,000
Total liabilities		1,435,000		1,100,000
Stockholders' equity:
Common stock, $15 par		760,000		760,000
Retained earnings		1,198,200		849,000
Total stockholders’ equity		1,958,200		1,609,000
Total liabilities and stockholders' equity	$	3,393,200	$	2,709,000

Sabin Electronics
Comparative Income Statement and Reconciliation
	This Year		Last Year
Sales	$	5,350,000	$	4,560,000
Cost of goods sold		3,945,000		3,520,000
Gross margin		1,405,000		1,040,000
Selling and administrative expenses		667,000		562,000
Net operating income		738,000		478,000
Interest expense		72,000		72,000
Net income before taxes		666,000		406,000
Income taxes (30%)		199,800		121,800
Net income		466,200		284,200
Common dividends		117,000		96,000
Net income retained		349,200		188,200
Beginning retained earnings		849,000		660,800
Ending retained earnings	$	1,198,200	$	849,000

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 3/10, n/30. All sales are on account.

Required:

1. To assist in approaching the bank about the loan, Paul has asked you to compute the following ratios for both this year and last year:

a. The amount of working capital.

b. The current ratio.

c. The acid-test ratio.

d. The average collection period. (The accounts receivable at the beginning of last year totaled $320,000.)

e. The average sale period. (The inventory at the beginning of last year totaled $570,000.)

f. The operating cycle.

g. The total asset turnover. (The total assets at the beginning of last year were $2,630,000.)

h. The debt-to-equity ratio.

i. The times interest earned ratio.

j. The equity multiplier. (The total stockholders’ equity at the beginning of last year totaled $1,599,000.)

2. For both this year and last year:

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

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

• Req 1
• Req 2A
• Req 2B

To assist in approaching the bank about the loan, Paul has asked you to compute the following ratios for both this year and last year:

a. The amount of 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 $320,000.) (Use 365 days in a year. Round your intermediate calculations and final answers to 2 decimal place.)
e. The average sale period. (The inventory at the beginning of last year totaled $570,000.) (Use 365 days in a year. Round your intermediate calculations and final answers to 2 decimal place.)
f. The operating cycle. (Use 365 days in a year. Round your intermediate calculations and final answers to 2 decimal place.)
g. The total asset turnover. (The total assets at the beginning of last year were $2,630,000.) (Round your answers to 2 decimal places.)
h. The debt-to-equity ratio. (Round your answers to 2 decimal places.)
i. The times interest earned ratio. (Round your answers to 2 decimal places.)
j. The equity multiplier. (The total stockholders’ equity at the beginning of last year totaled $1,599,000.) (Round your answers to 2 decimal places.)

Answer 1

Ans. A	Working capital =     Total current assets - Total current liabilities
	This year	$1,707,000 - $835,000	$872,000
	Last year	$1,309,000 - $500,000	$809,000
Ans. B	Current ratio   =   Total current assets / Total current liabilities
	This year	$1,707,000 / $835,000	2.04 : 1
	Last year	$1,309,000 / $500,000	2.62 : 1
Ans. C	Acid test ratio   =   (Total current assets - Inventory - Prepaid expenses) / Total current liabilities
	This year	($1,707,000 - $1,015,000 - $26,000) / $835,000	0.80 : 1
	Last year	($1,309,000 - $665,000 - $29,000) / $500,000	1.23 : 1
Ans. D	Average collection period   =   No. of days in year / Net credit sales * Average accounts receivables
	This year	365 / $5,350,000 * $469,000	32.00	days
	Last year	365 / $4,560,000 * $345,000	27.62	days
	*Average receivable = (Beginning receivables + Ending receivables) / 2
	This year	($370,000 + $568,000) / 2	$469,000
	Last year	($320,000 + $370,000) / 2	$345,000
Ans. E	Average sales period   =   No. of days in year / Cost of goods sold * Average inventory
	This year	365 / $3,945,000 * $840,000	77.72	days
	Last year	365 / $3,520,000 * $602,500	62.48	days
	*Average inventory = (Beginning inventory + Ending inventory) / 2
	This year	($665,000 + $1,015,000) / 2	$840,000
	Last year	($570,000 + $635,000) / 2	$602,500
Ans. F	Operating cycle = Average collection period + Average sales period
	This year	32 + 77.72	109.72	days
	Last year	27.62 + 62.48	90.10	days