Warning: foreach() argument must be of type array|object, bool given in /var/www/html/web/app/themes/studypress-core-theme/template-parts/header/mobile-offcanvas.php on line 20

Financial Statement Analysis Case

Ragatz, Inc.

Ragatz, Inc., a drug company, reported the following information. The company prepares its financial statements in accordance with GAAP.

2017 (000)

Current liabilities

\(554,114

Convertible subordinated debts

648,020

Total liabilities

1,228,313

Stockholder’s equity

176,413

Net income

58,333

Analysts attempting to compare Ragatz to drug companies that issue debt with detachable warrants may face a challenge due to differences in accounting for convertible debt.

Instructions

(a) Compute the following ratios for Ragatz, Inc. (Assume that year-end balances approximate annual averages.)

(1) Return on assets.

(2) Return on common stock equity.

(3) Debt to assets ratio.

(b) Briefly discuss the operating performance and financial position of Ragatz. Industry averages for these ratios in 2017 were ROA 3.5%; return on equity 16%; and debt to assets 75%. Based on this analysis, would you make an investment in the company’s 5% convertible bonds? Explain.

(c) Assume you want to compare Ragatz to an IFRS company like Merck (which issues nonconvertible debt with detachable warrants). Assuming that the fair value of the equity component of Ragatz’s convertible bonds is \)150,000, how would you adjust the analysis above to make valid comparisons between Ragatz and Merck?

Short Answer

Expert verified

(a) Financial ratios

Return on assets

4.15%

Return on equity

33.06%

Debt to asset

87.44%

(b) The company is performing well, but the company's financial position is not good.

(c) Financial ratios under IFRS

Return on assets

4.15%

Return on equity

17.87%

Debt to asset

76.76%

Step by step solution

01

Definition of Financial Ratios

The comparison made for financial analysis between the various items reported on the financial statement is known as financial ratios. These ratios are used for making a summarized report on the company’s performance.

02

Calculation of ratios

(1) Return on assets

Returnonassets=NetIncomeTotalAssets×100=$58,333$176,413+$1,228,313×100=$58,333$1,404,726×100=4.15%

(2) Return on common stock equity

Returnonequity=NetIncomeStockholdersequity×100=$58,333$176,413×100=33.06%

(3) Debt to assets ratio

Debttoassetsratio=Total DebtsTotal Assets=$1,228,313$176,413+$1,228,313×100=$1,228,313$1,404,726×100=87.44%

03

Operating performance of the company

  1. According to the industry average return on assets, the business entity is performing well because the actual ratio of the business entity is more than the industry average.

2.The industry average return on common stock equity is 16%, and the actual return on the common stock company is generating equals 33.06%. It means that the company generates more profit for stockholders than industry averages.

3.The company's debt to asset ratio is 87.44%, which is more than the industry average of 75%, which means that the company is not in a good financial position as most of its assets are financed through debt.

Even if the company is performing well, the debt to the asset is very high, reflecting that investing in the company’s bonds is riskier. But the investors might be attracted to the convertible bonds because the return on equity is higher than might increase the price of the shares, and investors can generate gain from such an increase in the prices.

04

Adjustments in the financial ratios

Under IFRS, the convertible bonds' equity and debt components of the convertible bonds are recorded separately. While under GAAP, these are not reported separately; therefore, the equity component of convertible bonds will be reported separately, which will affect the ratios.

2017 (000)

Current liabilities

$554,114

Convertible subordinated debts

($648,020$150,000)

498,020

Total liabilities ($1,228,313$150,000)

1,078,313

Stockholder’s equity

($176,413+$150,000)

326,413

Net income

58,333

(1) Return on assets

Returnonassets=NetIncomeTotalAssets×100=$58,333$176,413+$1,228,313×100=$58,333$1,404,726×100=4.15%

(2) Return on common stock equity

Returnonequity=NetIncomeStockholdersequity×100=$58,333$326,413×100=17.87%

(3) Debt to assets ratio

Debttoassetsratio=Total DebtsTotal Assets=$1,078,313$176,413+$1,228,313×100=$1,078,313$1,404,726×100=76.76%

Unlock Step-by-Step Solutions & Ace Your Exams!

  • Full Textbook Solutions

    Get detailed explanations and key concepts

  • Unlimited Al creation

    Al flashcards, explanations, exams and more...

  • Ads-free access

    To over 500 millions flashcards

  • Money-back guarantee

    We refund you if you fail your exam.

Over 30 million students worldwide already upgrade their learning with Vaia!

One App. One Place for Learning.

All the tools & learning materials you need for study success - in one app.

Get started for free

Most popular questions from this chapter

What are the arguments for giving separate accounting recognition to the conversion feature of debentures?

E16-28 (L05) (EPS with Warrants) Howat Corporation earned \(360,000 during a period when it had an average of 100,000 shares of common stock outstanding. The common stock sold at an average market price of \)15 per share during the period. Also outstanding were 15,000 warrants that could be exercised to purchase one share of common stock for $10 for each warrantexercised.

Instructions

(a) Are the warrants dilutive?

(b) Compute basic earnings per share.

(c) Compute diluted earnings per share.

(Conversion of Bonds) Vargo Company has bonds payable outstanding in the amount of \(500,000, and the Premium on Bonds Payable account has a balance of \)7,500. Each \(1,000 bond is convertible into 20 shares of preferred stock of parvalue of \)50 per share. All bonds are converted into preferred stock.

(Conversion of Bonds) Aubrey Inc. issued \(4,000,000 of 10%, 10-year convertible bonds on June 1, 2017, at 98 plus accrued interest. The bonds were dated April 1, 2017, with interest payable April 1 and October 1. Bond discount is amortized semi-annually on a straight-line basis.On April 1, 2018, \)1,500,000 of these bonds were converted into 30,000 shares of $20 par value common stock. Accrued interest was paid in cash at the time of conversion.

(a) Prepare the entry to record the interest expense at October 1, 2017. Assume that accrued interest payable was credited when the bonds were issued. (Round to nearest dollar.)

(b) Prepare the entry(ies) to record the conversion on April 1, 2018. (Book value method is used.) Assume that the entry to record amortization of the bond discount and interest payment has been made

Tomba Corporation had 300,000 shares of common stock outstanding on January 1, 2017. On May 1, Tomba issued 30,000 shares. (a) Compute the weighted-average number of shares outstanding if the 30,000 shares were issued for cash. (b) Compute the weighted-average number of shares outstanding if the 30,000 shares were issued in a stock dividend.

See all solutions

Recommended explanations on Business Studies Textbooks

View all explanations

What do you think about this solution?

We value your feedback to improve our textbook solutions.

Study anywhere. Anytime. Across all devices.

Sign-up for free