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Chapter 24: Question 5P-b (page 1452)

(Dividend Policy Analysis) Matheny Inc. went public 3 years ago. The board of directors will be meeting shortly after the end of the year to decide on a dividend policy. In the past, growth has been financed primarily through the retention of earnings. A stock or a cash dividend has never been declared. Presented below is a brief financial summary of Matheny Inc.’s operations.

(\(000 omitted)

2018

2017

2016

2015

2014

Sales revenue

\)20,000

\(16,000

\)14,000

\(6,000

\)4,000

Net income

2,400

14,000

800

700

250

Average total assets

22,000

19,000

11,500

4,200

3,000

Current assets

8,000

6,000

3,000

1,200

1,000

Working capital

3,600

3,200

1,200

500

400

Common shares:

Number of shares

Outstanding (000)

Average market price

2,000

\(9

2,000

\)6

2,000

$4

20

-

20

-

Instructions

  1. Compute the return on assets, profit margin on sales, earnings per share, price-earnings ratio, and current ratio for each of the 5 years for Matheny Inc.

Short Answer

Expert verified

Highest

Lowest

Return on asset

16.7%

7.0%

The profit margin on sales

12.0%

5.7%

Earnings per share

$35.00

$0.40

Price-earnings ratio

10 times

7.5 times

Current ratio

2.14 times

1.67 times

Step by step solution

01

Meaning of Return on asset

Return on assets can be determined by dividing net income by average total assets. It is represented by percentage (%). It is used by the company to test the return of the company to the shareholders.

02

Computation of Return on Assets

2018

2017

2016

2015

2014

Return on assets

$2,400

$22,000

10.9%

$14,000

$19,000

7.4%

$800

$11,500

7.0%

$700

$4,200

16.7%

$250

$3,000

8.3%

Working notes:

All the Return on Assets can be calculated by using the formula as follows:

Returnonasset=NetincomeAveragetotalassets

Like for the year 2018

Returnonasset=NetincomeAveragetotalassets=2,400022,000=10.9%

03

Calculation of Profit Margin of sales

2018

2017

2016

2015

2014

The profit margin on sales

$2,400

$20,000

12.0%

$14,000

$ 16,000

8.8%

$800

$ 14,000

5.7%

$700

$ 6,000

11.7%

$250

$ 4,000

6.3%

Working Notes:

All the profit margins on sales can be calculated by using the formula as follows:

Returnonasset=NetincomeAveragetotalasset

Like for the year 2018

Profitmarginonsales=NetincomeSalesrevenue=2,40020,000=12%

04

Calculation of earnings per share

2018

2017

2016

2015

2014

Earnings per share

$2,400

2,000

$1.20

$14,000

2,000

$0.70

$800

2,000

$0.40

$700

20

$35.00

$250

20

$12.50

Working Notes:

All the earnings per share can be calculated by using the formula as follows:

Earningpershare=NetincomeNumberofsharesoutstanding

Like for the year 2018

Earningpershare=NetincomeNumberofsharesoutstanding=2,40002,000=$1.20

05

Calculation of Price-earnings ratio

2018

2017

2016

2015

2014

Price-earnings ratio

$9

$1.20

7.5 times

$6

$0.70

8.6 times

$4

$0.40

10 times

Working Notes:

All the price-earnings ratios can be calculated by using the formula as follows:

Priceearningratio=AveragemarketpriceEarningpershare

Like for the year 2018

Priceearningratio=AveragemarketpriceEarningpershare=$9$1.20=7.5times

06

Calculation of the current ratio

2018

2017

2016

2015

2014

Current ratio

$8,000

$ 4,400

1.82 times

$6,000

$2,800

2.14 times

$3,000

$1,800

1.67 times

$1,200

$700

1.71 times

$1,000

$600

1.67 times

Working Notes:

All the price-earnings ratios can be calculated by using the formula as follows:

Currentratio=CurrentassetsCurrentLiabilities

For Current calculating liabilities, use the following formula.

Currentliabilities=Currentassets-Workingcapital

Like for the year 2018

Currentliabilities=Currentassets-Workingcapital=$8,000-$3,600=$4,400

Currentratio=CurrentassetCurrentliabilities=$8,000$4,400=1.82times

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Most popular questions from this chapter

What is the relationship of the asset turnover to the return on assets?

Okay. Last fall, someone with a long memory and an even longer arm reached into that bureau drawer and came out with a moldy cheese sandwich and the equally moldy notion of corporate forecasts. We tried to find out what happened to the cheese sandwich—but, rats!, even recourse to the Freedom of Information Act didn’t help. However, the forecast proposal was dusted off, polished up and found quite serviceable. The SEC, indeed, lost no time in running it up the old flagpole—but no one was very eager to salute. Even after some of the more objectionable features—compulsory corrections and detailed explanations of why the estimates went awry—were peeled off the original proposal.

Seemingly, despite the Commission’s smiles and sweet talk, those craven corporations were still afraid that an honest mistake would lead them down the primrose path to consent decrees and class action suits. To lay to rest such qualms, the Commission last week approved a “Safe Harbor” rule that, providing the forecasts were made on a reasonable basis and in good faith, protected corporations from litigation should the projections prove wide of the mark (as only about 99% are apt to do).

Instructions

  1. Why are corporations concerned about presenting profit forecasts?

(Horizontal and Vertical Analysis) Presented below is the comparative balance sheet for Gilmour Company.

GILMOUR COMPANY

COMPARATIVE BALANCE SHEET

AS OF DECEMBER 31, 2018 AND 2017

December 31

2018

2017

Assets

Cash

\( 180,000

\) 275,000

Accounts receivable (net)

220,000

155,000

Short-term investments

270,000

150,000

Inventories

1,060,000

980,000

Prepaid expenses

25,000

25,000

Plant & equipment

2,585,000

1,950,000

Accumulated depreciation

(1,000,000)

(750,000)

\(3,340,000

(2,785,000)

Liabilities and Stockholders’ Equity

Accounts payable

\) 50,000

\( 75,000

Accrued expenses

170,000

200,000

Bonds payable

450,000

190,000

Common stock

2,100,000

1,770,000

Retained earnings

570,000

550,000

\)3,340,000

(2,785,000)

Instructions

(Round to two decimal places.)

  1. Of what value is the additional information provided in part (b)?

(Ratio Computations and Additional Analysis) Bradburn Corporation was formed 5 years ago through a public subscription of common stock. Daniel Brown, who owns 15% of the common stock, was one of the organizers of Bradburn and is its current president. The company has been successful, but it currently is experiencing a shortage of funds. On June 10, 2018, Daniel Brown approached the Topeka National Bank, asking for a 24-month extension on two \(35,000 notes, which are due on June 30, 2018, and September 30, 2018. Another note of \)6,000 is due on March 31, 2019, but he expects no difficulty in paying this note on its due date. Brown explained that Bradburn’s cash flow problems are due primarily to the company’s desire to finance a \(300,000 plant expansion over the next 2 fiscal years through internally generated funds. The commercial loan officer of Topeka National Bank requested the following financial reports for the last 2 fiscal years

BRADBURN CORPORATION

BALANCE SHEET

MARCH 31

Assets

2018

2017

Cash

\) 18,200

\( 12,500

Notes receivable

148,000

132,000

Accounts receivable (net)

131,800

125,500

Inventories (at cost)

105,000

50,000

Plant & Equipment (net of depreciation)

1,449,000

1,420,500

Total assets

\)1,852,000

\(1,740,500

Liabilities and Stockholders’ Equity

Accounts payable

\) 79,000

\( 91,000

Notes payable

76,000

61,500

Accrued liabilities

9,000

6,000

Common stock (130,000 shares, \)10 par)

1,300,000

1,300,000

Retained earnings*

388,000

282,000

Total liabilities and stockholders’ equity

\(1,852,000

\)1,740,500

*Cash dividends were paid at the rate of \(1 per share in the fiscal year 2017 and \)2 per share in the fiscal year 2018.

BRADBURN CORPORATION

INCOME STATEMENT

FOR THE FISCAL YEARS ENDED MARCH 31

2018

2017

Sales revenue

\(3,000,000

\)2,700,000

Cost of goods sold*

1,530,000

1,425,000

Gross margin

1,470,000

1,275,000

Operating expenses

860,000

780,000

Income before income taxes

610,000

495,000

Income taxes (40%)

244,000

198,000

Net income

\( 366,000

\) 297,000

Depreciation charges on the plant and equipment of \(100,000 and \)102,500 for fiscal years ended March 31, 2017, and 2018, respectively, are included in the cost of goods sold.

c). Assume that the percentage changes experienced in fiscal year 2018 as compared with fiscal year 2017 for sales and cost of goods sold will be repeated in each of the next 2 years. Is Bradburn’s desire to finance the plant expansion from internally generated funds realistic? Discuss.

The following information was described in a note of Canon Packing Co.

“During August, Holland Products Corporation purchased 311,003 shares of the Company’s common stock which constitutes approximately 35% of the stock outstanding. Holland has since obtained representation on the Board of Directors.”

“An affiliate of Holland Products Corporation acts as a food broker for Canon Packing in the greater New York City marketing area. The commissions for such services after August amounted to approximately $20,000.”

Why is this information disclosed?

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