Chapter 13, Problem 13.2AP

(a)

To determine

Financial Ratios: Financial ratios are the metrics used to evaluate the liquidity, capabilities, profitability, and overall performance of a company.

To compute: Earnings per share

Answer to Problem 13.2AP

$\begin{array}{c}\text{Earnings per share}=\frac{\text{Net income}}{\text{Average outstanding common shares}}\\ =\frac{\$218,000}{58,000\text{ shares}}\\ =\$3.76\end{array}$

Explanation of Solution

Given info: Income statement and Balance sheet

A portion of profit that an individual earns from each share is referred to earnings per share.

Formula:

$\begin{array}{l}\text{Earnings }\\ \text{per share}\end{array}\}=\frac{\text{Net income }-\text{Preferred dividends}}{\text{Weighted average number of common shares outstanding}}$

Conclusion

Hence, earnings per share are $3.76.

(b)

To determine

To compute: Return on shareholders’ equity

Answer to Problem 13.2AP

$\begin{array}{c}\begin{array}{l}\text{Return on common}\\ \text{stockholders' equity}\end{array}\}=\frac{\text{Net income}}{\text{Average stockholders' equity}}\times 100\\ =\frac{\$218,000}{\$534,400}\times 100\\ =40.79\%\end{array}$

Explanation of Solution

Given info: Income statement and Balance sheet

Rate of return on stockholders’ equity is used to determine the relationship between the net income and the average common equity that are invested in the company.

Formula: $\text{Rate of return }=\frac{\text{Net income }-\text{Preferred dividends}}{\text{Average common stockholder’s equity}}$

Average common stockholders’ equity is determined by dividing opening and closing total common stockholders’ equity by 2. It is calculated as follows:

$\begin{array}{c}\begin{array}{l}\text{Average stockholders'}\\ \text{ equity}\end{array}\}=\left[\frac{\begin{array}{l}\text{Stockholders' equity at the beginning of the year}\\ +\text{Stockholders' equity at the end of the year}\end{array}}{2}\right]\\ =\frac{\$465,400+\$603,400}{2}\\ =\$534,400\end{array}$

Conclusion

Hence, return on stockholders’ equity is 40.79%.

(c)

To determine

To compute: Return on assets ratio

Answer to Problem 13.2AP

$\begin{array}{c}\text{Return on assets}=\frac{\text{Net income}}{\text{Average assets}}\times 100\\ =\frac{\$218,000}{\$939,850}\times 100\\ =23.20\%\end{array}$

Explanation of Solution

Given info: Income statement and Balance sheet

Return on assets determines the particular company’s overall earning power.

Formula:

$\text{Rate of return on assets}=\frac{\text{Net}\text{income + Interest expense}}{\text{Average total assets}}$

Average total assets are determined by dividing opening and closing total assets by 2.

$\begin{array}{c}\text{Average assets}=\left[\frac{\begin{array}{l}\text{Assets at the beginning of the year}\\ +\text{Assets at the end of the year}\end{array}}{2}\right]\\ =\frac{\$852,800+\$1,026,900}{2}\\ =\$939,850\end{array}$

Conclusion

Hence, return on total assets ratio is 23.20%.

(d)

To determine

To compute: Current ratio

Answer to Problem 13.2AP

$\begin{array}{c}\text{Current ratio}=\frac{\text{Current assets}}{\text{Current liabilities}}\\ =\frac{\$377,900}{\$203,500}\\ =1.86\end{array}$

Explanation of Solution

Given info: Income statement and Balance sheet

Current ratio is used to determine the relationship between current assets and current liabilities. The ideal current ratio is 2:1.

Formula:

$\text{Current ratio}=\frac{\text{Current assets}}{\text{Current}\text{liabilities}}$

Conclusion

Hence, current ratio is 1.86:1.

(e)

To determine

To compute: Accounts receivable turnover ratio

Answer to Problem 13.2AP

$\begin{array}{c}\begin{array}{l}\text{Accounts receivable}\\ \text{turnover}\end{array}\}=\frac{\text{Net credit sales}}{\text{Average net accounts receivable}}\\ =\frac{\$1,890,540}{\$110,300}\\ =17.14\text{ times}\end{array}$

Explanation of Solution

Explanation

Given info: Income statement and Balance sheet

Accounts receivable turnover ratio is mainly used to evaluate the collection process efficiency. It helps the company to know the number of times the accounts receivable is collected in a particular time period. Main purpose of accounts receivable turnover ratio is to manage the working capital of the company.

Formula:

$\begin{array}{l}\text{Accounts receivables}\\ \text{ turnover ratio}\end{array}\}=\frac{\text{Net credit sales}}{\text{Average accounts receivables}}$

Average net accounts receivable is determined by dividing the sum of opening and closing accounts receivable by 2.

$\begin{array}{c}\begin{array}{l}\text{Average net }\\ \text{accounts receivable}\end{array}\}=\left[\frac{\begin{array}{l}\text{Accounts receivable at the beginning of the year}\\ +\text{Accounts receivable at the end of the year}\end{array}}{2}\right]\\ =\frac{\$102,800+\$117,800}{2}\\ =\$110,300\end{array}$

Conclusion

Hence, accounts receivable turnover ratio is 17.14 times.

(f)

To determine

To compute: Average collection period

Answer to Problem 13.2AP

$\begin{array}{c}\text{Average}\text{collection}\text{period}=\frac{\text{Days in accounting period }\left(365\text{days}\right)}{\text{Accounts receivables turnover}}\\ =\frac{365\text{days}}{17.14\text{times }\left(\text{From e}\right)}\\ =21.29days\end{array}$

Explanation of Solution

Given info: Income statement and Balance sheet

This ratio is used to measure the number of days a particular company takes to collect their accounts receivables.

Formula:

$\text{Average}\text{collection}\text{period}=\frac{\text{Days in accounting period }\left(365\text{days}\right)}{\text{Accounts receivables turnover}}$

Conclusion

Hence, the average collection period is 21.29 days.

(g)

To determine

To compute: Inventory turnover period

Answer to Problem 13.2AP

$\begin{array}{c}\text{Inventory turnover}=\frac{\text{Cost of goods sold}}{\text{Average inventory}}\\ =\frac{\$1,058,540}{\$120,750}\\ =8.77\text{ times}\end{array}$

Explanation of Solution

Given info: Income statement and Balance sheet

Inventory turnover ratio is used to determine the number of times inventory used or sold during the particular accounting period.

Formula:

$\text{Inventory turnover}=\frac{\text{Cost of goods sold}}{\text{Average inventory}}$

Average inventory is determined by dividing the sum of opening and closing inventory by 2. It is calculated as follows:

$\begin{array}{c}\text{Average inventory}=\left[\frac{\begin{array}{l}\text{Inventory at the beginning of the year}\\ +\text{Inventory at the end of the year}\end{array}}{2}\right]\\ =\frac{\$126,000+\$115,500}{2}\\ =\$120,750\end{array}$

Conclusion

Hence, the inventory turnover ratio is 8.77 times.

(h)

To determine

To compute: Days in inventory ratio

Answer to Problem 13.2AP

$\begin{array}{c}\text{Days in inventory}=\frac{\text{Days in accounting period}\left(365\text{days}\right)}{\text{Inventory turnover}}\\ =\frac{365\text{days}}{8.77\text{times }\left(\text{From g}\right)}\\ =41.62\text{days}\end{array}$

Explanation of Solution

Given info: Income statement and Balance sheet

Days’ in inventory are used to determine number of days a particular company takes to make sales of the inventory available with them.

Formula:

$\text{Days' sales in inventory}=\frac{\text{Days in accounting period}}{\text{Inventory turnover}}$

Conclusion

Hence, the days’ sales in inventory ratio are 41.62 days.

(i)

To determine

To compute: Times interest earned ratio

Answer to Problem 13.2AP

$\begin{array}{c}\text{Times interest earned}=\frac{\text{Net income}+\text{Income tax expense}+\text{Interest expense}}{\text{Interest expense}}\\ =\frac{\$218,000+\$92,000+\$22,000}{\$22,000}\\ =\frac{\$308,000}{\$18,000}\\ =17.1\text{ times}\end{array}$

Explanation of Solution

Given info: Income statement and Balance sheet

Times - interest earned ratio quantifies the number of times the earnings before interest and taxes can pay the interest expense.

Formula:

$\begin{array}{l}\text{Times-interest-earned}\\ \text{ratio }\end{array}\}=\frac{\text{Net income}+\text{Income tax expense}+\text{Interest expense}}{\text{Interest expense}}$

Conclusion

Hence, the times interest earned ratio is 17.1 times.

j)

To determine

To compute: Asset turnover ratio

Answer to Problem 13.2AP

$\begin{array}{c}\text{Asset turnover}=\frac{\text{Net sales}}{\text{Average assets}}\\ =\frac{\$1,890,540}{\$939,850}\\ =2.01\text{ times}\end{array}$

Explanation of Solution

Given info: Income statement and Balance sheet

Asset turnover ratio is used to determine the asset’s efficiency towards sales.

Formula: $\text{Asset turnover }=\frac{\text{Net}\text{revenue}}{\text{Average total assets}}$

Average assets are determined by dividing the sum of opening and closing assets by 2. It is calculated as follows:

$\begin{array}{c}\text{Average assets}=\left[\frac{\begin{array}{l}\text{Assets at the beginning of the year}\\ +\text{Assets at the end of the year}\end{array}}{2}\right]\\ =\frac{\$852,800+\$1,026,900}{2}\\ =\$939,850\end{array}$

Conclusion

Hence, the asset turnover ratio is 2.01 times.

k)

To determine

To compute: Debt to asset ratio

Answer to Problem 13.2AP

$\begin{array}{c}\text{Debt to assets ratio}=\frac{\text{Total liabilities}}{\text{Total assets}}\\ =\left[\frac{\$423,500}{\$1,026,900}\right]\times 100\\ =41.24\%\end{array}$

Explanation of Solution

Given info: Income statement and Balance sheet

Debt to asset ratio is used by the company to determine how well the company is able to survive the losses without damaging the creditors’ interest. It is determined by dividing total debt and total assets.

Formula:

$\begin{array}{l}\text{Debt to assets}\\ \text{ratio}\end{array}\}\text{=}\frac{\text{Total debt}}{\text{Total assets}}$

Conclusion

Hence, the debt to assets ratio is 41.24%.

h)

To determine

To compute: Free cash flow

Answer to Problem 13.2AP

$\begin{array}{c}\text{Free cash flow = }\left(\begin{array}{l}\text{Net cash provided by operating activities }\\ \text{– Capital expenditures – Cash dividends}\end{array}\right)\\ =\$220,000-\$136,000-\$70,000\\ =\$14,000\end{array}$

Explanation of Solution

Given info: Income statement and Balance sheet

Free cash flow determines to know the extent of how company survives in a longer time period.  Free cash flow is determined by deducting net cash provided by operating activities and capital expenditures and cash dividends.

Formula:

$\text{Free cash flow = }\left(\begin{array}{l}\text{Net cash provided by operating activities }\\ \text{– Capital expenditures – Cash dividends}\end{array}\right)$

Conclusion

Hence, the free cash flow is $14,000.