Chapter 4, Problem 23P

Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977

Chapter
Section

Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977
Textbook Problem

RATIO ANALYSIS Data for Barry Computer Co. and its industry averages follow. a. Calculate the indicated ratios for Barry. b. Construct the DuPont equation for both Barry and the industry. c. Outline Barry’s strengths and weaknesses as revealed by your analysis. d. Suppose Barry had doubled its sales as well as its inventories, accounts receivable, and common equity during 2015. How would that information affect the validity of your ratio analysis? (Hint: Think about averages and the effects of rapid growth on ratios if averages are not used. No calculations are needed.) Barry Computer Company: Balance Sheet as of December 31, 2015 (in Thousands) Cash $77,500 Accounts payable$129,000 Receivables 336,000 Other current liabilities 117,000 Inventories 241,500 Notes payable to bank 84,000 Total current assets $655,000 Total current liabilities$330,000       Long-term debt 256,500 Net fixed assets 292,500 Common equity 361,000 Total assets $947,500 Total liabilities and equity$947,500 Barry Computer Company: Income Statement for Year Ended December 31, 2015 (in Thousands) Sales $1,607,500 Cost of goods sold Materials$717,000 Labor 453,000 Heat, light, and power 68,000 Indirect labor 113,000 Depreciation 41,500 1,392,500 Gross profit $215,000 Selling expenses 115,000 General and administrative expenses 30,000 Earnings before interest and taxes (EBIT)$70,000 Interest expense 24,500 Earnings before taxes (EBT) $45,500 Federal and state income taxes (40%) 18,200 Net income$27,300 Ratio Barry Industry Average Current _____ 2.0× Quick _____ 1.3× Days sales outstandinga _____ 35 days Inventory turnover _____ 6.7× aCalculation is based on a 365-day year Total assets turnover _____ 3.0× Profit margin _____ 1.20% ROA _____ 0 ROE _____ 9.00% ROIC _____ 0 TIE _____ 3.0× Debt/Total capital _____ 47.00%

(a)

Summary Introduction

To determine: The indicated ratios.

Ratio Analysis

Ratio is used to compare two arithmetical figures. In case of the ratio analysis of the company the financial ratios are calculated. The financial ratio examines the performance of the company and is used in comparing with other same business. It indicates relationship of two or more parts of financial statements.

Explanation

Current Ratio

Current ratio is a part of liquidity ratio, which reflects the capability of the company to payback its short term debts. It is calculated based on the current assets and current liabilities that a company possesses in an accounting period.

Given,

Current asset is $655,000. Current liabilities are$330,000.

The formula to calculate present current ratio is

Current Ratio=Current AssetsCurrent Liabilities

Substitute $655,000 for current ratio and$330,000 for current liabilities.

Current Ratio=$655,000$330,000=1.98times

Therefore, current ratio is 1.98 times.

Quick Ratio

It is also known as acid-test ratio which is used to determine the company’s capability to satisfy dues using only liquid assets. The less liquid assets inventory is excluded due to this it shows liquidity in better manner.

Given,

Current asset is $655,000. Inventory is$241,500.

The formula of quick ratio is,

Quick Ratio=Current AssetsInventoryCurrent Liabilities

Substitute $655,000 for current assets,$330,000 for current liabilities and $241,500 for inventory. Quick Ratio=$655,000$241,500$330,000=$413,500$330,000=1.25 times

Therefore, quick ratio is 1.25 times.

Days sales Outstanding

Days sales outstanding is used to measure days that a business usually requires to collects its receivable in average. It indicates account receivable of the firm and firm’s efficiency in collecting the account receivable.

Given,

Receivables are $336,000. Annual sale is$1,607,500.

The formula to calculate Days sales outstanding is,

Days Sales Outstanding=Account ReceivableAnnual Sales/365=Account ReceivablesAnnual Sales×365

Substitute $336,000 for account receivables and$1,607,500 for annual sales.

Days Sales Outstanding=Account ReceivablesAnnual Sales×365=$336,000$1,607,500×365=76.29 days

Therefore, Days sales outstanding are 76.29 days.

Inventory Turnover Ratio

Inventory turnover reflects the number of times average inventory is converted into sales during a period. It is used to measure the efficiency of business operations.

Given,

Total sale is $1,607,500. Total inventory is$241,500.

The formula of inventory turnover ratio is,

Inventory Turnover Ratio=Total SalesTotal Inventory

Substitute $1,607,500 for total sales and$241,500 for total inventory.

Inventory Turnover Ratio=$1,607,500$241,500=6.66

Therefore, inventory turnover ratio is 6.66 times.

Total Assets Turnover Ratio

It indicates how effectively the asset of company is utilized. Total asset is the sum of current assets and fixed assets.

Given,

Total sales are $1,607,500. Total assets are$947,500.

The formula of total assets turnover is,

Total Assets Turnover=Total SalesTotal Assets

Substitute $1,607,500 for total sales and$947,500 for total assets.

Total Assets Turnover=$1,607,500$947,500=1.70 times

Therefore, total assets turnover is 1.70 times.

Return on Assets

It is a profitability ratio. This ratio shows profit earning capability on per dollar of assets. It shows the percentage of net income on total assets. Higher the returns on assets better the profitability. Total assets include fixed as well as current assets.

Given,

Net income is$27,300. Total assets are$947,500.

The formula of return on asset is,

ROA=Net IncomeTotal Value of Asset

Substitute $27,300 for net income and$947,500 for total value of assets

(b)

Summary Introduction

To construct: The Du Pont equation for both Company B and Industry.

Du Pont Equation

Among all ratios, return on equity is very common. It shows the value of the firm. Improvement in the ROE is considered as valued addition to the firm. ROE can be linked with other ratios. Analysis of such ratios will indicate proper reason for change in ROE. The combination is known as Du Pont equation which is shown below,

ROE =Net IncomeCommon Equity=Net IncomeTotal Assets×Total AssetsCommon Equity=Net IncomeSales×SalesTotal Assets×Total AssetsCommon Equity=Profit Margin× Total Assets Turnover Ratio×Equity Multiplier

(c)

Summary Introduction

To outline: The strength and weakness of the company revealed by the analysis.

(d)

Summary Introduction

To identify: The effect in the ratio analysis of the company, supposing the company had doubled its sales as well as inventories, account receivables and common equity during 2015.

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