Chapter 15: Q9RQ (page 835)
Briefly describe the ratios that can be used to evaluate a company’s ability to sell merchandise inventory and collect receivables.
Inventory turnover ratio,
Gross Profit ratio,
Accounts Receivable ratio etc.
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Question: Using ratios to decide between two stock investments
Assume that you are purchasing an investment and have decided to invest in a company in the digital phone business. You have narrowed the choice to All Digital Corp. and Green Zone, Inc. and have assembled the following data.
Selected income statement data for the current year:
All digital | Green Zone | |
Net sales revenue (all on credit) | \(417,925 | \)493,115 |
Cost of goods sold | 209,000 | 258,000 |
Interest expenses | 0 | 14,000 |
Net income | 58,000 | 72,000 |
Selected balance sheet and market price data at the end of the current year:
All digital | Green Zone | |
Current assets: | ||
Cash | \(23,000 | \)18,000 |
Short-term investment | 37,000 | 17,000 |
Accounts receivables, Net | 39,000 | 49,000 |
Merchandise inventory | 64,000 | 102,000 |
Prepaid expenses | 21,000 | 17,000 |
Total current assets | \(184,000 | \)203,000 |
Total assets | \(263,000 | \)326,000 |
Total current liabilities | 105,000 | 99,000 |
Total liabilities | 105,000 | 134,000 |
Common stock: | ||
\(1 par (10,000 shares) | 10,000 | |
\)2 par (14,000 shares) | 28,000 | |
Total stockholder’s equity | 158,000 | 192,000 |
Market price per share of common stock | 92.80 | 128.50 |
Dividend paid per common share | 1.20 | 0.90 |
Selected balance sheet data at the beginning of the current year:
All digital | Green Zone | |
Balance sheet: | ||
Accounts receivables, Net | \(41,000 | \)54,000 |
Merchandise inventory | 81,000 | 89,000 |
Total assets | 258,000 | 277,000 |
Common stock: | ||
\(1 par (10,000 shares) | 10,000 | |
\)2 par (14,000 shares) | 28,000 |
Your strategy is to invest in companies with low price/earnings ratios but in good financial shape. Assume that you have analyzed all other factors and that your decision depends on the results of ratio analysis.
Requirements
1. Compute the following ratios for both companies for the current year:
a. Acid-test ratio
b. Inventory turnover
c. Days’ sales in receivables
d. Debt ratio
e. Earnings per share of common stock
f. Price/earnings ratio
g. Dividend payout
2. Decide which company’s stock better fits your investment strategy
Big Beautiful Photo Shop has asked you to determine whether the company’s ability to pay current liabilities and total liabilities improved or deteriorated during 2018. To answer this question, you gather the following data:
2018 | 2017 | |
Cash | \(58,000 | \)47,000 |
Short-term Investments | 34,000 | 0 |
Net Accounts Receivable | 140,000 | 124,000 |
Merchandise Inventory | 217,000 | 272,000 |
Total Assets | 530,000 | 565,000 |
Total Current Liabilities | 288,000 | 205,000 |
Long-term Notes Payable | 40,000 | 50,000 |
Income from Operations | 165,000 | 158,000 |
Interest Expense | 55,000 | 41,000 |
Compute the following ratios for 2018 and 2017, and evaluate the company’s ability to pay its current liabilities and total liabilities:
a. Current ratio
b. Cash ratio
c. Acid-test ratio
d. Debt ratio
e. Debt to equity ratio
Using ratios to evaluate a stock investment
Comparative financial statement data of Sanfield, Inc. follow:
| SANFIELD, INC. Comparative Income Statement Years Ended December 31, 2018, and 2017 | ||
2018 | 2017 | |
Net Sales Revenue | \( 462,000 | \) 430,000 |
Cost of Goods Sold | 236,000 | 213,000 |
Gross Profit | 226,000 | 217,000 |
Operating Expense | 135,000 | 133,000 |
Income from Operations | 91,000 | 84,000 |
Interest Expense | 8,000 | 12,000 |
Income Before Income Tax | 83,000 | 72,000 |
Income Tax Expense | 18,000 | 22,000 |
Net Income | \( 65,000 | \) 50,000 |
| SANFIELD, INC. Comparative Balance Sheet December 31, 2018, and 2017 | |||
2018 | 2017 | 2016 | |
Asset | |||
Current Assets: | |||
Cash | \( 99,000 | \) 97,000 | |
Accounts Receivable, Net | 109,000 | 117,000 | \( 100,000 |
Merchandise Inventory | 142,000 | 164,000 | 207,000 |
Prepaid Expenses | 15,000 | 5,000 | |
Total Current Assets | 365,000 | 383,000 | |
Property, Plant, and Equipment, Net | 215,000 | 177,000 | |
Total Assets | \) 580,000 | \( 560,000 | \) 599,000 |
Liabilities | |||
Total Current Liabilities | \( 222,000 | \) 244,000 | |
Long-term Liabilities | 113,000 | 92,000 | |
Total Liabilities | 335,000 | 336,000 | |
Stockholders’ Equity | |||
Preferred Stock, 4% | 92,000 | 92,000 | |
Common Stockholders’ Equity, no par | 153,000 | 132,000 | 85,000 |
Total Liabilities and Stockholders’ Equity | \( 580,000 | \) 560,000 | |
1. Market price of Sanfield’s common stock: \(51.48 at December 31, 2018, and \)37.08 at December 31, 2017.
2. Common shares outstanding: 16,000 on December 31, 2018 and 15,000 on December 31, 2017 and 2016.
3. All sales are on credit.
Requirements
1. Compute the following ratios for 2018 and 2017:
2. Decide (a) whether Sanfield’s ability to pay debts and sell inventory improved or deteriorated during 2018 and (b) whether the investment attractiveness of its common stock appears to have increased or decreased.
Traditional Mills’s balance sheet appears as follows (amounts in thousands):
Use the following ratio data to complete Traditional Mills’s balance sheet.
Current ratio is 0.72.
2. Acid-test ratio is 0.36.
The financial statements of Valerie’s Natural Foods include the following items:
Compute the following ratios for the current year:
Current ratio
Cash ratio
Acid-test ratio
Inventory turnover
Day’s sales in inventory
Day’s sales in receivables
Gross profit percentage
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