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 $4,000 $2,500 $1,000
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
a. 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?
b. Suppose Thornton is using FIFO for inventory valuation and Edison is using LIFO. Comment on the comparability of information between these two companies.
c. If all short-term notes payable are due on July 11 at 8 a.m., comment on each company’s ability to settle its obligation in a timely manner.

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

19X5 19X4
Net credit sales $832,000 $760,000
Cost of goods sold 440,000 350,000
Cash, Dec. 31 125,000 110,000
Accounts receivable, Dec. 31 180,000 140,000
Inventory, Dec. 31 70,000 50,000
Accounts payable, Dec. 31 115,000 108,000

The company is planning to borrow $300,000 via a 90-day bank loan to cover short-term operating needs.
a. Compute the accounts receivable and inventory turnover ratios for 19X5. Alaska rounds all calculations to two decimal places.
b. Study the ratios from part (a) and comment on the company’s ability to repay a bank loan in 90 days.
c. Suppose that Alaska’s major line of business involves the processing and distribution of fresh and frozen fish throughout the United States. Do you have any concerns about the company’s inventory turnover ratio? Briefly discuss.

3. Profitability ratios, trading on the equity. Digital Relay has both preferred and common stock outstanding. The com¬pany reported the following information for 19X7:
Net sales $1,500,000
Interest expense 120,000
Income tax expense 80,000
Preferred dividends 25,000
Net income 130,000
Average assets 1,100,000
Average common stockholders’ equity 400,000
a. Compute the profit margin on sales and the rates of return on assets and common stockholders’ equity, rounding calculations to two decimal places.
b. Does the firm have positive or negative financial leverage? Briefly ex¬plain.

4. Financial statement construction via ratios. Incomplete financial statements of Lock Box, Inc., are presented below.

LOCK BOX, INC.
Income Statement
For the Year Ended December 31, 19X3
Sales $ ?
Cost of goods sold ?
Gross profit $15,000,000
Operating expenses & interest ?
Income before tax $ ?
Income taxes, 40% ?
Net income $ ?

LOCK BOX, INC.
Balance Sheet
December 31, 19X3
Assets
Cash
Accounts receivable
Inventory
Property, plant, &. equipment
Total assets $ ?
?
?
8,000,000
$24,000,000
Liabilities & Stockholders’ Equity
Accounts payable
Notes payable (short-term)
Bonds payable
Common stock
Retained earnings
Total liabilities & stockholders’ equity $ ?
600,000 4,600,000
2,000,000
?
$24,000,000

Further information:
1. Cost of goods sold is 60% of sales. All sales are on account.
2. The company’s beginning inventory is $5 million; inventory turnover is 4.
3. The debt to total assets ratio is 70%.
4. The profit margin on sales is 6%.
5. The firm’s accounts receivable turnover is 5. Receivables increased by $400,000 during the year.
Using the preceding data, complete the income statement and the balance sheet.

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