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Problem 13-13A (45 minutes)
Effect on
Ratio
Reason for Increase, Decrease, or No Effect
1.
Decrease
Declaring a cash dividend will increase current liabilities,
but have no effect on current assets. Therefore, the
current ratio will decrease.
2.
Increase
A sale of inventory on account will increase the quick
assets (cash, accounts receivable, marketable securities)
but have no effect on the current liabilities. For this
reason, the acid-test ratio will increase. The same effect
would result regardless of whether the inventory was sold
at cost, at a profit, or at a loss. That is, the acid-test ratio
would increase in all cases; the only difference would be
the amount of the increase.
3.
Increase
The interest rate on the bonds is only 8%. Since the
company’s assets earn at a rate of return of 10%, positive
leverage would come into effect, increasing the return to
the common stockholders.
4.
Decrease
A decrease in net income would mean less income
available to cover interest payments. Therefore, the
times-interest-earned ratio would decrease.
5.
Increase
Payment of a previously declared cash dividend will
reduce both current assets and current liabilities by the
same amount. An equal reduction in both current assets
and current liabilities will always result in an increase in
the current ratio, so long as the current assets exceed the
current liabilities.
6.
No Effect
The dividend payout ratio is a function of the dividends
paid per share in relation to the earnings per share.
Changes in the market price of a stock have no effect on
Problem 13-13A (continued)
Effect on
Ratio
Reason for Increase, Decrease, or No Effect
7.
Increase
A write-off of inventory will reduce the inventory balance,
thereby increasing the turnover in relation to a given level
of sales.
8.
Decrease
Sale of inventory at a profit will increase the assets of a
company. The increase in assets will be reflected in an
increase in retained earnings, which is part of stockholders’
equity. An increase in stockholders’ equity will result in a
decrease in the ratio of assets provided by creditors as
compared to assets provided by owners.
9.
Decrease
Extended credit terms for customers means that customers
on the average will be taking longer to pay their bills. As a
result, the accounts receivable will “turn over,” or be
collected, less frequently during a given year.
10.
Decrease
A common stock dividend will result in a greater number of
shares outstanding, with no change in the underlying
assets. The result will be a decrease in the book value per
share.
11.
No Effect
Book value per share is dependent on historical costs of
already completed transactions as reflected on a company’s
balance sheet. It is not affected by current market prices
for the company’s stock.
12.
No Effect
Payments on account reduce cash and accounts payable by
equal amounts; thus, the net amount of working capital is
not affected.
13.
Decrease
The stock dividend will increase the number of common
shares outstanding, thereby reducing the earnings per
share.
Problem 13-13A (continued)
Effect on
Ratio
Reason for Increase, Decrease, or No Effect
14.
Decrease
Payments to creditors will reduce the total liabilities of a
company, thereby decreasing the ratio of total debt to total
equity.
15.
Decrease
A purchase of inventory on account will increase current
liabilities, but will not increase the quick assets (cash,
accounts receivable, marketable securities). Therefore, the
ratio of quick assets to current liabilities will decrease.
16.
No Effect
Write-off of an uncollectible account against the Allowance
for Bad Debts will have no effect on total current assets.
For this reason, the current ratio will remain unchanged.
17.
Increase
The price-earnings ratio is obtained by dividing the market
price per share by the earnings per share. If the earnings
per share remains unchanged, and the market price goes
up, then the price-earnings ratio will increase.
18.
Decrease
The dividend yield ratio is obtained by dividing the dividend
per share by the market price per share. If the dividend per
share remains unchanged and the market price goes up,
then the yield will decrease.
Problem 13-14A (30 minutes)
1. a. Computation of working capital:
Current assets:
Cash .......................................
$ 50,000
Marketable securities ................
30,000
Accounts receivable, net ...........
200,000
Inventory ................................
210,000
Prepaid expenses .....................
10,000
Total current assets (a) ...............
500,000
Current liabilities:
Accounts payable .....................
150,000
Notes due in one year ..............
30,000
Accrued liabilities .....................
20,000
Total current liabilities (b)............
200,000
Working capital (a) – (b) .............
$300,000
b. Computation of the current ratio:
Current assets $500,000
= = 2.5
Current liabilities $200,000
c. Computation of the acid-test ratio:
Cash + Marketable securities +
Accounts receivable $280,000
= = 1.4
Current liabilities $200,000
Problem 13-14A (continued)
2.
The Effect on
Working
Current
Acid-Test
Transaction
Capital
Ratio
Ratio
(a)
Issued capital stock for cash .........
Increase
Increase
Increase
(b)
Sold inventory at a gain ................
Increase
Increase
Increase
(c)
Wrote off uncollectible accounts ....
None
None
None
(d)
Declared a cash dividend ..............
Decrease
Decrease
Decrease
(e)
Paid accounts payable ..................
None
Increase
Increase
(f)
Borrowed on a short-term note .....
None
Decrease
Decrease
(g)
Sold inventory at a loss .................
Decrease
Decrease
Increase
(h)
Purchased inventory on account ....
None
Decrease
Decrease
(i)
Paid short-term notes ...................
None
Increase
Increase
(j)
Purchased equipment for cash ......
Decrease
Decrease
Decrease
(k)
Sold marketable securities at a loss
Decrease
Decrease
Decrease
(l)
Collected accounts receivable ........
None
None
None
Problem 13-15A (90 minutes)
This Year
Last Year
1.
a.
Earnings before interest and income
taxes (a) ................................................................
$1,560,000
$1,020,000
Interest expense (b) ................................
$360,000
$300,000
Times interest earned (a) ÷ (b) ................................
4.3
3.4
b.
Total liabilities (a) ..........................................................
$7,500,000
$5,760,000
Stockholders’ equity (b) ................................
$9,600,000
$9,120,000
Debt-to-equity ratio (a) ÷ (b) ................................
0.78
0.63
c.
Gross margin (a) ....................................
$3,150,000
$2,580,000
Sales (b) ...............................................
$15,750,000
$12,480,000
Gross margin percentage (a) ÷ (b) .........
20.0%
20.7%
d.
Net income ..........................................
$ 840,000
$ 504,000
Add after-tax cost of interest:
$360,000 × (1 – 0.30) .......................
252,000
$300,000 × (1 – 0.30) .......................
210,000
Total (a) ..............................................
$ 1,092,000
$ 714,000
Average total assets (b) .......................
$15,990,000
$13,920,000
Return on total assets (a) ÷ (b) ............
6.8%
5.1%
e.
Net income (a) ....................................
$ 840,000
$ 504,000
Average total stockholders’ equity (b) ...
$ 9,360,000
$ 9,084,000
Return on equity (a) ÷ (b) ....................
9.0%
5.6%
f.
Leverage is positive for this year because the return on equity
(9.0%) is greater than the return on total assets (6.8%). For last
year, leverage is also positive because the return on equity (5.6%) is
greater than the return on total assets (5.1%).
Problem 13-15A (continued)
This Year
Last Year
2.
a.
Net income (a) .......................................
$840,000
$504,000
Average number of common shares
outstanding (b) ...................................
100,000
100,000
Earnings per share (a) ÷ (b) ...................
$8.40
$5.04
b.
Dividends per share (a) ..........................
$3.60
$2.52
Market price per share (b) ......................
$72.00
$40.00
Dividend yield ratio (a) ÷ (b) ..................
5.0%
6.3%
c.
Dividends per share (a) ..........................
$3.60
$2.52
Earnings per share (b) ............................
$8.40
$5.04
Dividend payout ratio (a) ÷ (b) ...............
42.9%
50.0%
d.
Market price per share (a) .......................
$72.00
$40.00
Earnings per share (b) .............................
$8.40
$5.04
Price-earnings ratio (a) ÷ (b) ...................
8.57
7.94
Notice from the data given in the problem that the typical P/E ratio
for companies in Lydex Company’s industry is 10. Since Lydex
Company presently has a P/E ratio of only 8.57, investors appear to
regard its potential for earnings growth unfavorably relative to other
companies in the industry. That is, investors are willing to pay only
8.57 times current earnings for a share of Lydex Company’s stock, as
compared to 10 times current earnings for a share of stock for the
Problem 13-15A (continued)
Notice that the market value of common stock is below its book value
This Year
Last Year
3.
a.
Current assets ........................................
$7,800,000
$5,940,000
Current liabilities .....................................
3,900,000
2,760,000
Working capital .......................................
$3,900,000
$3,180,000
b.
Current assets (a) ...................................
$7,800,000
$5,940,000
Current liabilities (b) ................................
$3,900,000
$2,760,000
Current ratio (a) ÷ (b) .............................
2.0
2.15
c.
Quick assets (a) ......................................
$3,660,000
$3,360,000
Current liabilities (b) ................................
$3,900,000
$2,760,000
Acid-test ratio (a) ÷ (b) ...........................
0.94
1.22
d.
Sales on account (a) ...............................
$15,750,000
$12,480,000
Average receivables (b) ...........................
$2,250,000
$1,680,000
Accounts receivable turnover (a) ÷ (b) .....
7.0
7.4
Average collection period,
365 days ÷ turnover .............................
52.1 days
49.3 days
e.
Cost of goods sold (a) ................................
$12,600,000
$9,900,000
Average inventory balance (b) ................................
$3,150,000
$2,160,000
Inventory turnover ratio (a) ÷ (b) ................................
4.0
4.6
Average sale period,
365 days ÷ Inventory turnover ratio .............................
91.3 days
79.3 days
f.
Average sale period ........................................................
91.3 days
79.3 days
Average sale period ........................................................
52.1 days
49.3 days
Operating cycle ..............................................................
143.4 days
128.6 days
Problem 13-15A (continued)
This Year
Last Year
g.
Sales (a) ................................................................
$15,750,000
$12,480,000
Average total assets (b) ................................
$15,990,000
$13,920,000
Total asset turnover (a) ÷ (b) ................................
0.99
0.90
4. With respect to profitability, the return on total assets has improved
from 5.1% to 6.8%; however, 6.8% is well below the industry average
of 9.5%. Regarding debt management, the times interest earned ratio
has increased from 3.4 to 4.3; however, 4.3 is below the industry
8.57 is below the industry average of 10. In terms of asset
management, Lydex’s average sale period and average collection period
Problem 13-16A (30 minutes)
1.
Lydex Company
Comparative Balance Sheets
This Year
Last Year
Current assets:
Cash ...................................................
5.6
%
8.5
%
Marketable securities ............................
0.0
2.0
Accounts receivable, net .......................
15.8
12.1
Inventory ............................................
22.8
16.1
Prepaid expenses .................................
1.4
1.2
Total current assets ................................
45.6
39.9
Plant and equipment, net ........................
54.4
60.1
Total assets ............................................
100.0
%
100.0
%
Current liabilities ....................................
22.8
%
18.5
%
Note payable, 10% .................................
21.1
20.2
Total liabilities ........................................
43.9
38.7
Stockholders’ equity:
Common stock, $78 par value ...............
45.6
52.4
Retained earnings ................................
10.5
8.9
Total stockholders’ equity ........................
56.1
61.3
Total liabilities and equity ........................
100.0
%
100.0
%
Problem 13-16A (continued)
2.
Lydex Company
Comparative Income Statements
This Year
Last Year
Sales .....................................................
100.0
%
100.0
%
Cost of goods sold ...................................
80.0
79.3
Gross margin ...........................................
20.0
20.7
Selling and administrative expenses ..........
10.1
12.5
Net operating income ...............................
9.9
8.2
Interest expense ......................................
2.3
2.4
Net income before taxes ..........................
7.6
5.8
Income taxes (30%) ................................
2.3
1.7
Net income ..............................................
5.3
%
4.0
%*
*Due to rounding, figures may not fully reconcile down a column.
3. The company’s current position has declined substantially between the
two years. Cash this year represents only 5.6% of total assets, whereas
13-15 for a ratio analysis of the current assets.) Apparently a part of the
financing required to build inventories was supplied by short-term
creditors, as evidenced by the increase in current liabilities.
fixed.
Problem 13-17A (30 minutes)
a. It is becoming more difficult for the company to pay its bills as they
come due. Although the current ratio has improved over the three years,
the acid-test ratio is down. Also notice that the accounts receivable and
inventory are both turning more slowly, indicating that an increasing
increasing. With sales increasing (and undoubtedly cost of goods sold
also increasing), the average level of inventory must be increasing as
well to service the larger volume of sales.
e. The market price is going down. The dividends paid per share over the
three-year period are unchanged, but the dividend yield is going up.
Problem 13-18A (60 minutes)
This Year
Last Year
1.
a.
Current assets .........................................
$1,520,000
$1,090,000
Current liabilities ......................................
800,000
430,000
Working capital ........................................
$ 720,000
$ 660,000
b.
Current assets (a) ....................................
$1,520,000
$1,090,000
Current liabilities (b) ................................
$800,000
$430,000
Current ratio (a) ÷ (b) .............................
1.90
2.53
c.
Quick assets (a) ......................................
$550,000
$468,000
Current liabilities (b) ................................
$800,000
$430,000
Acid-test ratio (a) ÷ (b) ...........................
0.69
1.09
d.
Sales on account (a) ................................
$5,000,000
$4,350,000
Average receivables (b) ............................
$390,000
$275,000
Accounts receivable turnover (a) ÷ (b) .....
12.8
15.8
Average collection period: 365 days ÷
Accounts receivable turnover .................
28.5 days
23.1 days
e.
Cost of goods sold (a) ..............................
$3,875,000
$3,450,000
Average inventory (b) ..............................
$775,000
$550,000
Inventory turnover ratio(a) ÷ (b) ..............
5.0
6.3
Average sales period:
365 days ÷ Inventory turnover ratio .......
73.0 days
57.9 days
f.
Average sale period .................................
73.0 days
57.9 days
Average collection period .........................
28.5 days
23.1 days
Operating cycle .......................................
101.5 days
81.0 days
g.
Sales (a) .................................................
$5,000,000
$4,350,000
Average total assets (b) ...........................
$2,730,000
$2,440,000
Total asset turnover (a) ÷ (b) ...................
1.83
1.78
Problem 13-18A (continued)
This Year
Last Year
h.
Total liabilities (a) ....................................
$1,400,000
$1,030,000
Stockholders’ equity (b) ...........................
$1,600,000
$1,430,000
Debt-to-equity ratio (a) ÷ (b) ...................
0.875
0.720
i.
Net income before interest and taxes (a) ..
$472,000
$352,000
Interest expense (b) ................................
$72,000
$72,000
Times interest earned (a) ÷ (b) ................
6.6
4.9
j.
Average total assets (a) ...........................
$2,730,000
$2,440,000
Average stockholders’ equity (b) ...............
$1,515,000
$1,425,000
Equity multiplier (a) ÷ (b) ........................
1.80
1.71
Problem 13-18A (continued)
2.
a.
Sabin Electronics
Common-Size Balance Sheets
This Year
Last Year
Current assets:
Cash ......................................................
2.3
%
6.1
%
Marketable securities ..............................
0.0
0.7
Accounts receivable, net .........................
16.0
12.2
Inventory ...............................................
31.7
24.4
Prepaid expenses ...................................
0.7
0.9
Total current assets ...................................
50.7
44.3
Plant and equipment, net ..........................
49.3
55.7
Total assets ..............................................
100.0
%
100.0
%
Current liabilities .......................................
26.7
%
17.5
%
Bonds payable, 12% .................................
20.0
24.4
Total liabilities ........................................
46.7
41.9
Stockholders’ equity:
Common stock, $10 par ..........................
25.0
30.5
Retained earnings ..................................
28.3
27.6
Total stockholders’ equity ..........................
53.3
58.1
Total liabilities and equity ..........................
100.0
%
100.0
%
