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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	$	1,040,000	$	1,280,000
Marketable securities		0		300,000
Accounts receivable, net		3,020,000		2,120,000
Inventory		3,680,000		2,300,000
Prepaid expenses		270,000		210,000
Total current assets		8,010,000		6,210,000
Plant and equipment, net		9,680,000		9,130,000
Total assets	$	17,690,000	$	15,340,000
Liabilities and Stockholders' Equity
Liabilities:
Current liabilities	$	4,090,000	$	3,140,000
Note payable, 10%		3,720,000		3,120,000
Total liabilities		7,810,000		6,260,000
Stockholders' equity:
Common stock, $75 par value		7,500,000		7,500,000
Retained earnings		2,380,000		1,580,000
Total stockholders' equity		9,880,000		9,080,000
Total liabilities and stockholders' equity	$	17,690,000	$	15,340,000

Lydex Company Comparative Income Statement and Reconciliation
	This Year		Last Year
Sales (all on account)	$	15,940,000	$	14,380,000
Cost of goods sold		12,752,000		10,785,000
Gross margin		3,188,000		3,595,000
Selling and administrative expenses		1,216,000		1,636,000
Net operating income		1,972,000		1,959,000
Interest expense		372,000		312,000
Net income before taxes		1,600,000		1,647,000
Income taxes (30%)		480,000		494,100
Net income		1,120,000		1,152,900
Common dividends		320,000		576,450
Net income retained		800,000		576,450
Beginning retained earnings		1,580,000		1,003,550
Ending retained earnings	$	2,380,000	$	1,580,000

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	1.2
Average collection period	32	days
Average sale period	60	days
Return on assets	8.6	%
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 $13,150,000.)

e. The return on equity. (Stockholders’ equity at the beginning of last year totaled $8,503,550. There has been no change in common stock over the last two years.)

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

2)

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 $110 per share and that at the end of last year it was $78. 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)

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 $1,750,000.) (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 $2,110,000.) (Use 365 days in a year. Round your intermediate calculations and final answers to 2 decimal place.)

f. The operating cycle. (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 totaled $14,690,000.) (Round your final answers to 2 decimal places.)

Answer 1

1)
	This Year	Last Year
a.The times interest earned ratio.
Earnings before interest and income taxes (a)	1,972,000	1,959,000
Interest expense (b)	372,000	312,000
Times interest earned (a) ÷ (b)	5.30	6.28
b. The debt-to-equity ratio.
Total liabilities (a)	7,810,000	6,260,000
Stockholders’ equity (b)	9,880,000	9,080,000
Debt-to-equity ratio (a) ÷ (b)	0.79	0.69
c.The gross margin percentage.
Gross margin (a)	3,188,000	3,595,000
Sales (b)	15,940,000	14,380,000
Gross margin percentage (a) ÷ (b)	20.00%	25.00%
d.The return on total assets. (Total assets at the beginning of last year were $13,150,000.)
Net income	1,120,000	1,152,900
Add after-tax cost of interest:
$360,000 × (1 – 0.30) ; $300,000 × (1 – 0.30)	260400	218400
Total (a)	1380400	1371300
Average total assets (b)	16515000	14,245,000
Return on total assets (a) ÷ (b)	8.36%	9.63%
e.The return on equity. (Stockholders’ equity at the beginning of last year totaled $8,503,550. There has been no change in common stock over the last two years.)
Net income (a)	1120000	1152900
Average total stockholders’ equity (b)	9,480,000	8,791,775
Return on equity (a) ÷ (b)	11.81%	13.11%
f.Is the company’s financial leverage positive or negative?
The company's financial leverage is positive for this year because the return on equity (11.81%) is greater than the return on total assets (8.36%). For last year, leverage is also positive because the return on equity (13.11%) is greater than the return on total assets (9.63%).
2)	This Year	Last Year
a) Earnings per share
Net income (a)	1,120,000	1,152,900
Average number of common shares outstanding (b)	100000	100000
Earnings per share (a) ÷ (b)	11.2	11.529
b) Dividend yield ratio
Dividends per share (a)	3.2	5.7645
Market price per share (b)	110	78
Dividend yield ratio (a) ÷ (b)	2.91%	7.39%
c)
Dividends per share (a)	$         3.20	$         5.76
Earnings per share (b)	$       11.20	$       11.53
Dividend payout ratio (a) ÷ (b)	28.57%	50.00%
d)
Market price per share (a)	110	78
Earnings per share (b)	$       11.20	$       11.53
Price-earnings ratio (a) ÷ (b)	9.82	6.77
e)
Stockholders’ equity (a)	9,880,000	9,080,000
Average number of common shares outstanding (b)	100000	100000
Book value per share (a) ÷ (b)	$       98.80	$       90.80
3)
a)	This Year	Last Year
Current assets	8,010,000	6,210,000
Current liabilities	4,090,000	3,140,000
Working capital	3,920,000	3,070,000
b)
Current assets (a)	8,010,000	6,210,000
Current liabilities (b)	4,090,000	3,140,000
Current ratio (a) ÷ (b)	1.96	1.98
c)
Quick assets (a) (CA - Inventory - Prepaid Exp.)	4,060,000	3,700,000
Current liabilities (b)	4,090,000	3,140,000
Acid-test ratio (a) ÷ (b)	0.99266504	1.17834395
d)The average collection period. (The accounts receivable at the beginning of last year totaled $1,750,000.)
Sales on account (a)	15,940,000	14,380,000
Average receivables (b)	2,570,000	1,935,000
Accounts receivable turnover (a) ÷ (b)	6.20	7.43
Average collection period, = 365 days ÷ turnover	58.85	49.12	Days
e) The average sale period. (The inventory at the beginning of last year totaled $2,110,000.)
Cost of goods sold (a)	12,752,000	10,785,000
Average inventory balance (b)	2,990,000	2,205,000
Inventory turnover ratio (a) ÷ (b)	4.26	4.89
Average sale period, 365 days ÷ Inventory turnover ratio	85.58	74.62	days
f)
Average collection period,	58.85	49.12
Average sale period	85.58	74.62
Operating cycle	144.43	123.74	days
g)
Sales (a)	15,940,000	14,380,000
Average total assets (b)	16515000	15,015,000
Total asset turnover (a) ÷ (b)	0.97	0.96