ACC 205 Week 1,2,3,4,5

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ACC 205 Week Five Exercise Assignment

Financial Ratios

1. Liquidity ratios. Edison, Stagg, and Thornton have the following financial information at the close of business on July 10:

	Edison	Stagg	Thornton
Cash	$6,000	$5,000	$4,000
Short-term investments	3,000	2,500	2,000
Accounts receivable	2,000	2,500	3,000
Inventory	1,000	2,500	4,000
Prepaid expenses	800	800	800
Accounts payable	200	200	200
Notes payable: short-term	3,100	3,100	3,100
Accrued payables	300	300	300
Long-term liabilities	3,800	3,800	3,800

1. Compute the current and quick ratios for each of the three companies. (Round calculations to two decimal places.) Which firm is the most liquid? Why?

Current Ratio = Current Assets / Current Liabilities

Edison = 12,800 / 3,600

= 3:56

Stagg = 13,800 / 3,600

= 3.83

Thornton = 13,800 / 3,600

= 3.83

Quick Ratio = Quick Assets / Current Liabilities

Edison = 11,000 / 3,600

= 3.05:1

Stagg = 10,000 / 3,600

= 2.78:1

Thornton = 9,000 / 3,600

= 2.5:1

The Current ratios of Stagg and Thornton are higher than Edison. Hence these two are better in liquidity than Edison.

However, in terms of quick ratio, Edison is the best, having highest quick ratio of 3.05:1. Stagg is on second position, having quick ratio of 2.78:1, which is better than Thornton.

Therefore, the liquidity position of Edison, will be rated as the best.

2. Computation and evaluation of activity ratios. The following data relate to Alaska Products, Inc:

	20X5	20X4
Net credit sales	$832,000	$760,000
Cost of goods sold	530,000	400,000
Cash, Dec. 31	125,000	110,000
Accounts receivable, Dec. 31	205,000	156,000
Inventory, Dec. 31	70,000	50,000
Accounts payable, Dec. 31	115,000	108,000

1. Compute the accounts receivable and inventory turnover ratios for 20X5. Alaska rounds all calculations to two decimal places.

Accounts receivable Turnover ratio

= Net Sales ÷ Average Accounts receivable

= 832,000 ÷ [(205,000 + 156,000) / 2]

= 832,000 ÷ 180,500

= 4.61

Inventory Turnover ratio

= Cost of goods sold ÷ Average Inventory

= 530,000 ÷ [(70,000 + 50,000) / 2]

= 530,000 ÷ 60,000

= 8.83

3. Profitability ratios, trading on the equity. Digital Relay has both preferred and common stock outstanding. The company reported the following information for 20X7:

Net sales	$1,750,000
Interest expense	120,000
Income tax expense	80,000
Preferred dividends	25,000
Net income	130,000
Average assets	1,200,000
Average common stockholders' equity	500,000

1. Compute the profit margin on sales and the rates of return on assets and common stockholders' equity, rounding calculations to two decimal places.

Profit margin on Sales = Net Income / Net sales

= 130,000 / 1,750,000

= 7.43%

Rate of Return on Assets = Net Income / Average Assets

= 130,000 / 1,200,000

= 10.83%

Return on Common stockholder’s equity

= Net Income/Average common stockholder’s equity

= 130,000 / 500,000

= 26%

2. Does the firm have positive or negative financial leverage? Briefly explain.

The firm has total assets $1,200,000, whereas the common stockholder’s equity is only $500,000. It indicates that balance $700,000, is liabilities or debt.

The company has an interest expense of $120,000, which indicates that there is huge debt on the company.

The positive side of this is that the company is able to arrange the debt, but the negative point is that the company is heavily indebted. Too much dependence on borrowed funds is not a good indicator. The debt capital ratio is very high.

4. Horizontal analysis. Mary Lynn Corporation has been operating for several years. Selected data from the 20X1 and 20X2 financial statements follow.

20X2	20X1
Current Assets	$86,000	$80,000
Property, Plant, and Equipment (net)	99,000	90,000
Intangibles	25,000	50,000
Current Liabilities	40,800	48,000
Long-Term Liabilities	153,000	160,000
Stockholders’ Equity	16,200	12,000
Net Sales	500,000	500,000
Cost of Goods Sold	322,500	350,000
Operating Expenses	93,500	85,000

a. Prepare a horizontal analysis for 20X1 and 20X2. Briefly comment on the results of your work.

Mary Lynn Corporation
	20X2	20X1	Increase / Decrease
			Amount	Percentage
Current Assets	86,000	80,000	6,000	7.50%
Property, Plant, and Equipment (net)	99,000	90,000	9,000	10.00%
Intangibles	25,000	50,000	-25,000	-50.00%
Current Liabilities	40,800	48,000	-7,200	-15.00%
Long-Term Liabilities	1,53,000	1,60,000	-7,000	-4.38%
Stockholders’ Equity	16,200	12,000	4,200	35.00%
Net Sales	5,00,000	5,00,000	0	0.00%
Cost of Goods Sold	3,22,500	3,50,000	-27,500	-7.86%
Operating Expenses	93,500	85,000	8,500	10.00%

Comments:

· Although there is no change in Net Sales, Cost of goods sold has decreased by 7.86%. This is a positive variance and this will increase the net income.

· Although there is no change in Net Sales, Operating expense has increased by 10%. This is a negative variance and this will decrease the net income.

· Decrease in Intangible assets, may be due to amortization.

· Decrease in current liabilities and increase in current assets will give increase to current ratio. It will make current ratio stronger.

· Decrease in long term liabilities, indicates the repayment of debts. This will make the financial position of the company strong.

5.Vertical analysis. Mary Lynn Corporation has been operating for several years. Selected data from the 20X1 and 20X2 financial statements follow.

20X2	20X1
Current Assets	$86,000	$80,000
Property, Plant, and Equipment (net)	99,000	80,000
Intangibles	25,000	50,000
Current Liabilities	40,800	48,000
Long-Term Liabilities	153,000	150,000
Stockholders’ Equity	16,200	12,000
Net Sales	500,000	500,000
Cost of Goods Sold	322,500	350,000
Operating Expenses	93,500	85,000

a. Prepare a vertical analysis for 20X1 and 20X2. Briefly comment on the results of your work.

Mary Lynn Corporation
	20X2	20X1

Current Assets	86,000	40.95%	80,000	36.36%
Property, Plant, and Equipment (net)	99,000	47.14%	90,000	40.91%
Intangibles	25,000	11.90%	50,000	22.73%
Total Assets	2,10,000	100.00%	2,20,000	100.00%

Current Liabilities	40,800	19.43%	48,000	21.82%
Long-Term Liabilities	1,53,000	72.86%	1,60,000	72.73%
Stockholders’ Equity	16,200	7.71%	12,000	5.45%
Total Liabilities & Shareholder’s Equity	2,10,000	100.00%	2,20,000	100.00%

Net Sales	5,00,000	100.00%	5,00,000	100.00%
Cost of Goods Sold	3,22,500	64.50%	3,50,000	70.00%
Operating Expenses	93,500	18.70%	85,000	17.00%

· Current Assets and Property Plant and equipment has increased in 20x2. It indicates more investments in the business.

· There is a decrease in current liabilities, however, long term liability is at the same level. It indicates the new investments have been made from increase in stockholder’s Equity.

· There is a decrease in cost of goods sold, which will increase the net income. However increase of operating expenses, without any increase in sales will decrease the net income.

6. Ratio computation. The financial statements of the Lone Pine Company follow.

	LONE PINE COMPANY
	Comparative Balance Sheets
	December 31, 20X2 and 20X1 ($000 Omitted)
	20X2	20X1
	Assets
	Current Assets
	Cash and Short-Term Investments	$400		$600
	Accounts Receivable (net)	3,000		2,400
	Inventories	3,000		2,300
	Total Current Assets	$6,400		$5,300
	Property, Plant, and Equipment
	Land	$1,700		$500
	Buildings and Equipment (net)	1,500		1,000
	Total Property, Plant, and Equipment	$3,200		$1,500
	Total Assets	$9,600		$6,800
	Liabilities and Stockholders’ Equity
	Current Liabilities
	Accounts Payable	$2,800		$1,700
	Notes Payable	1,100		1,900
	Total Current Liabilities	$3,900		$3,600
	Long-Term Liabilities
	Bonds Payable	4,100		2,100
	Total Liabilities	$8,000		$5,700
	Stockholders’ Equity
	Common Stock	$200		$200
	Retained Earnings	1,400		900
	Total Stockholders’ Equity	$1,600		$1,100
Total Liabilities and Stockholders’ Equity	$9,600		$6,800


	LONE PINE COMPANY
	Statement of Income and Retained Earnings
	For the Year Ending December 31,20X2 ($000 Omitted)
	Net Sales*		$36,000
	Less: Cost of Goods Sold	$20,000
	Selling Expense	6,000
	Administrative Expense	4,000
	Interest Expense	400
	Income Tax Expense	2,000	32,400
	Net Income		$3,600
	Retained Earnings, Jan. 1		900
	Ending Retained Earnings		$4,500
	Cash Dividends Declared and Paid		3,100
	Retained Earnings, Dec. 31		$1,400
	*All sales are on account.

Instructions

Compute the following items for Lone Pine Company for 20X2, rounding all calculations to two decimal places when necessary:

a. Quick ratio

= Quick Assets ÷ Current Liabilities

= 3,400 ÷ 3,900

= 0.87:1

b. Current ratio

= Current Assets ÷ Current Liabilities

= 6,400 ÷ 3,900

= 1.64:1

c. Inventory-turnover ratio

= Cost of goods sold ÷ Average Inventory

= 20,000 ÷ [(3,000 + 2,300) / 2]

= 7.55

d. Accounts-receivable-turnover ratio

= Net Credit Sales ÷ Average Net Accounts receivable

= 36,000 ÷ [(3,000 + 2,400) / 2]

= 13.33

e. Return-on-assets ratio

= Net Income ÷ Average Total Assets

= 3,600 ÷ [(9,600 + 6,800) / 2]

= 43.90%

f. Net-profit-margin ratio

= Net Income ÷ Net Sales

= 3,600 ÷ 36,000

= 10%

g. Return-on-common-stockholders’ equity

= Net Income ÷ Average common-stockholders’ equity

= 3,600 ÷ [(1,600 + 1,100) / 2]

= 266.67%

h. Debt-to-total assets

= Total Liabilities ÷ Total Assets

= 8,000 ÷ 9,600

= 0.83:1

i. Number of times that interest is earned

= Net Income before Income tax and interest expense ÷ Interest expense

= (3,600 + 2,000 + 400) ÷ 400

= 15 Times