Chapter 3, Problem 3.16E

(1)

To determine

Ratio Analysis:

Ratio analysis is a tool to analyze the financial statements of a company which expresses a mathematical relationship among the items of financial statements.

To determine: The current ratio

Explanation of Solution

Current ratio:

Current ratio is a liquidity ratio, which expresses the relationship between current assets and current liabilities. Current ratio displays the short-term liquidity position of a company. It depicts how the company’s current assets are used to pay current liabilities. Current ratio can be calculated by the following formula:

$\begin{array}{l}\text{Current ratio = }\frac{\text{Current assets}}{\text{Current liabilities}}\\ \end{array}$ $$

Determine total current assets:

$\begin{array}{c}\text{Current assets = }\left(\text{Cash}+\text{Short term investments}+\text{Accounts receivables}+\text{Inventories}\right)\\ =\$200+\$150+\$200+\$350\\ =\$900\\ \end{array}$

Determine total current liabilities:

Given, $\text{Current liabilities = \$400}$

$\begin{array}{c}\text{Current ratio = }\frac{\text{Current assets}}{\text{Current liabilities}}\\ =\frac{\$900}{\$400}\\ =2.25\end{array}$

Conclusion

The current ratio of HB Co. is 2.25.

(2)

To determine

The acid test ratio

Explanation of Solution

Acid - Test ratio:

Acid - test ratio or Quick ratio is a liquidity ratio, which displays how current liabilities are paid by the current assets excluding prepaid expenses and inventories. Acid - test ratio is used to measure the company’s immediate short term liquidity. Current assets include cash and cash equivalents, marketable securities and short term investments. Acid-test ratio can be calculated using the formula:

$\begin{array}{l}\text{Acid-test ratio = }\frac{\text{Quick assets}}{\text{Current liabilities}}\\ \end{array}$

Determine total quick assets:

$\begin{array}{c}\text{Quick assets = }\left(\text{Cash}+\text{Short term investments }+\text{Accounts receivables}\right)\\ =\$200+\$150+\$200\\ =\$550\end{array}$

Determine total current liabilities:

Given, $\text{Current liabilities = \$400}$

$\begin{array}{c}\text{Acid-test ratio = }\frac{\text{Quick assets}}{\text{Current liabilities}}\\ \text{=}\frac{\text{\$550}}{\text{\$400}}\\ \text{=1}\text{.375}\end{array}$

Conclusion

The acid-test ratio of HB Co. is 1.375.

(3)

To determine

Debt equity ratio:

Debt equity ratio is a long term solvency ratio, which expresses the relationship between own funds (shareholders’ equity) and loan funds (debt). This ratio shows the proportion of debts and shareholders’ equity to finance assets. It is calculated by dividing the total liabilities by total shareholders’ equity.

$\begin{array}{l}\text{Debt to equity ratio = }\frac{\text{Total liablities }}{\text{Total shareholders' equity }}\\ \end{array}$

To determine: The debt equity ratio

Explanation of Solution

Determine total liabilities:

$$ $\begin{array}{c}\text{Total liabilities = }\left(\text{Current liabilities}+\text{Long term liabilities}\right)\\ =\$400+\$350\\ =\$750\end{array}$

Determine total shareholders’ equity:

$\begin{array}{c}\text{Total shareholders' equity = Paid in capital}+\text{ Retained earnings}\\ \text{=\$750}+\text{\$400}\\ =\$1150\end{array}$

$\begin{array}{c}\text{Debt equity ratio = }\frac{\text{Total liabilities}}{\text{Total shareholders' equity}}\\ \text{=}\frac{\text{\$750}}{\text{\$1150}}\\ \text{=0}\text{.65}\end{array}$

Conclusion

The debt equity ratio of HB Co. is 0.65.

(4)

To determine

Times interest earned ratio:

Times interest earned ratio indicates the relationship between earnings before interest and tax (EBIT) and interest expense. The purpose of the ratio is to know the payment of interest expense with respect to the company’s earnings.

$\text{Times interest earned ratio = }\frac{\text{Net income + Interest expense}\text{+}\text{Income tax}}{\text{Interest expense}}$

To determine: The times interest earned ratio.

Explanation of Solution

$\begin{array}{c}\text{Times interest earned ratio = }\frac{\text{Net income}\text{+ Interest expense}\text{+}\text{Income tax}}{\text{Interest expense}}\\ =\frac{\$160+\$40+\$100}{\$40}\\ =\frac{\$300}{\$40}\\ =\text{7}\text{.5 times}\end{array}$

Conclusion

The times interest earned ratio of HB Co. is 7.5 times.