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Problem 15-19 (continued)
e. Financial leverage is positive in both years because the return on
3. All profitability measures and the earnings per share are trending
upwards, which is a good sign. However, the price-earnings ratio has
dropped from 9.18 to 7.14. This decline indicates investor concerns
Problem 15-20 (45 minutes)
1. The loan officer stipulated that the current ratio prior to obtaining the
loan must be higher than 2.0, the acid-test ratio must be higher than
1.0, and the interest on the loan must be less than four times net
operating income. These ratios are computed below:
Current assets
Current ratio =
Current liabilities
$290,000
= = 1.8 (rounded)
$164,000
Acid-test ratio = Cash + Marketable securities + Current receivables
Current liabilities
$70,000 + $0 + $50,000
= = 0.7 (rounded)
$164,000
Net operating income $20,000
= = 5.0
Interest on the loan $80,000 × 0.10 × (6/12)
The company would fail to qualify for the loan because both its current
ratio and its acid-test ratio are too low.
Problem 15-20 (continued)
Nevertheless, the old machine is an asset that could be turned into
cash. If this were done, the company would immediately qualify for the
loan because the $45 thousand in cash would be included in the
acid-test ratio requirements on the basis that they could be satisfied by
selling the old machine. Or she may approve the loan on the condition
Problem 15-21 (continued)
Computation of missing amounts:
a.
Earnings before interest and taxes
Times interest earned = Interest expense
Earnings before interest and taxes
= $80,000
= 6.75
Therefore, the earnings before interest and taxes for the year must be
$540,000.
b. Net income before taxes = $540,000 – $80,000 = $460,000
c. Income taxes = $460,000 × 30% tax rate = $138,000
d. Net income = $460,000 – $138,000 = $322,000
e.
Sales on account
Accounts receivable =
turnover Average accounts receivable balance
$4,200,000
=
Average accounts receivable balance
= 14.0
Therefore, the average accounts receivable balance for the year must
have been $300,000. Since the beginning balance was $270,000, the
ending balance must have been $330,000.
f.
Cash + Marketable securities + Current receivables
Acid-test ratio= Current liabilities
Cash + Marketable securities + Current receivables
= $320,000
= 1.25
Problem 15-21 (continued)
k. The interest expense for the year was $80,000 and the interest rate was
10%, the bonds payable must total $800,000.
l. Total liabilities = $320,000 + $800,000 = $1,120,000
m.
Net income - Preferred dividends
Earnings per share = Average number of common shares outstanding
$322,000
=
Average number of common shares outstanding
= $2.30
The stock is $5 par value per share, so the total common stock must be
$700,000 ($5 × 140,000 shares).
n.
Total liabilities
Debt-to-equity ratio = Stockholders' equity
$1,120,000
= Stockholders' equity
= 0.875
Therefore, the total stockholders’ equity must be $1,280,000.
o.
Total stockholders' equity = Common stock + Retained earnings
Retained earnings = Total stockholders' equity - Common Stock
= $1,280,000 - $700,000 = $580,000
