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	$	930,000	$	1,170,000
Marketable securities		0		300,000
Accounts receivable, net		2,580,000		1,680,000
Inventory		3,570,000		2,200,000
Prepaid expenses		250,000		190,000
Total current assets		7,330,000		5,540,000
Plant and equipment, net		9,460,000		9,020,000
Total assets	$	16,790,000	$	14,560,000
Liabilities and Stockholders' Equity
Liabilities:
Current liabilities	$	3,980,000	$	2,920,000
Note payable, 10%		3,640,000		3,040,000
Total liabilities		7,620,000		5,960,000
Stockholders' equity:
Common stock, $70 par value		7,000,000		7,000,000
Retained earnings		2,170,000		1,600,000
Total stockholders' equity		9,170,000		8,600,000
Total liabilities and stockholders' equity	$	16,790,000	$	14,560,000

Lydex Company Comparative Income Statement and Reconciliation
	This Year		Last Year
Sales (all on account)	$	15,830,000	$	13,280,000
Cost of goods sold		12,664,000		9,960,000
Gross margin		3,166,000		3,320,000
Selling and administrative expenses		1,402,000		1,592,000
Net operating income		1,764,000		1,728,000
Interest expense		364,000		304,000
Net income before taxes		1,400,000		1,424,000
Income taxes (30%)		420,000		427,200
Net income		980,000		996,800
Common dividends		410,000		498,400
Net income retained		570,000		498,400
Beginning retained earnings		1,600,000		1,101,600
Ending retained earnings	$	2,170,000	$	1,600,000

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	8.9	%
Debt-to-equity ratio	0.7
Times interest earned ratio	5.9
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 $13,040,000.)

e. The return on equity. (Stockholders’ equity at the beginning of last year totaled $8,101,600. There has been no change in common stock over the last two years.)

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

	This Year Last Year a. The times interest earned ratio b. The debt-to-equity ratio c. The gross margin percentage % % d. The return on total assets % % e. The return on equity % % f. Is the company’s financial leverage positive or negative?

Answer 1

Ans:

S.NO	Particulars	Formula	This year	Last year
1	The Times Interest Earned Ratio	Net Operating Income	1,764,000	1,728,000
		÷	÷	÷
		Interest Expense	364,000	304,000
			4.85	5.68	Times
2	Debt to Equity Ratio	Total liabilties	7,620,000	5,960,000
		÷	÷	÷
		Total stock holder's Equity	9,170,000	8,600,000
			0.83	0.69
3	Gross Margin Percentage	Gross Margin	3,166,000	3,320,000
		÷	÷	÷
		Net Sales	15,830,000	13,280,000
			20%	25%	%
4	Return on Total Assets	Net Income	980,000	996,800
		÷	÷	÷
		Avg.Total Assets	15675000	13800000
			6.3%	7.2%	%
5	Return on Equity	Net Income	980,000	996,800
		÷	÷	÷
		Avg.Total Equity	8885000	8350800
			11.0%	11.9%	%
6	Financial Leverage	Operating Income	1,764,000	1,728,000
		÷	÷	÷
		Net Income before taxes	1,400,000	1,424,000
			1.26	1.21
			Positive	Positive
	Particulars		This Year	Last Year
	1.The Times Interest Earned Ratio		4.85	5.68	Times
	2.Debt to Equity Ratio		0.83	0.69
	3.Gross Margin Percentage		20%	25%
	4.Return on Total Assets		6.3%	7.2%
	5.Return on Equity		11.0%	11.9%
	6.Financial Leverage		Positive	Positive

Hope this helped ! Let me know in case of any queries.