You have just been hired as a loan officer at Fairfield State Bank. Your supervi
ID: 2480410 • Letter: Y
Question
You have just been hired as a loan officer at Fairfield State Bank. Your supervisor has given you a file containing a request from Hedrick Company, a manufacturer of auto components, for a $1,000,000 five-year loan. Financial statement data on the company for the last two years are given below:
Marva Rossen, who just two years ago was appointed president of Hedrick Company, admits that the company has been “inconsistent” in its performance over the past several years. But Rossen argues that the company has its costs under control and is now experiencing strong sales growth, as evidenced by the more than 24% increase in sales over the last year. Rossen also argues that investors have recognized the improving situation at Hedrick Company, as shown by the jump in the price of its common stock from $30 per share last year to $46 per share this year. Rossen believes that with strong leadership and with the modernized equipment that the $1,000,000 loan will enable the company to buy, profits will be even stronger in the future.
Anxious to impress your supervisor, you decide to generate all the information you can about the company. You determine that the following ratios are typical of companies in Hedrick’sindustry:
You decide first to assess the rate of return that the company is generating. Compute the following for both this year and last year:
The return on total assets. (Total assets at the beginning of last year were $4,400,000.) (Round your answers to 1 decimal place. Omit the "%" sign in your response.)
The return on common stockholders’ equity. (Stockholders' equity at the beginning of last year totaled $5,004,701. There has been no change in preferred or common stock over the last two years.)(Round your intermediate calculations to the nearest whole number and final answers to 1 decimal place. Omit the "%" sign in your response.)
Is the company’s financial leverage positive or negative?
You decide next to assess the well-being of the common stockholders. For both this year and last year, compute:
The earnings per share. (Round your answers to 2 decimal places. Omit the "$" sign in your response.)
The dividend yield ratio for common stock. (Round your intermediate calculations to 2 decimal places and final answers to 1 decimal place. Omit the "%" sign in your response.)
The price-earnings ratio. (Round your intermediate calculations to 2 decimal places and final answers to 1 decimal place.)
The book value per share of common stock. (Round your answers to 2 decimal places. Omit the "$" sign in your response.)
The gross margin percentage. (Round your answers to 1 decimal place. Omit the "%" sign in your response.)
You decide, finally, to assess creditor ratios to determine both short-term and long-term debt paying ability. For both this year and last year, compute:
The average collection period. (The accounts receivable at the beginning of last year totaled $518,000.) (Round your intermediate calculations to 2 decimal places and final answers to the nearest whole number. Use 365 days in a year.)
The average sale period. (The inventory at the beginning of last year totaled $660,000.) (Round your intermediate calculations to 2 decimal places and final answers to the nearest whole number. Use 365 days in a year.)
You have just been hired as a loan officer at Fairfield State Bank. Your supervisor has given you a file containing a request from Hedrick Company, a manufacturer of auto components, for a $1,000,000 five-year loan. Financial statement data on the company for the last two years are given below:
Explanation / Answer
a.
Total assets at the beginning of last year were $4,400,000.
This Year
Last Year
Net income
$ 391,300
$ 381,500
Add after-tax cost of interest:
$121,000 × (1 – 0.30)
84,700
$115,000 × (1 – 0.30)
80,500
Total (a)
$ 476,000
$ 462,000
Average total assets (b)
$
5,238,400
$
5,675,150
Return on total assets (a) ÷ (b)
9.1%
8.1%
b. Stockholders' equity at the beginning of last year totaled $5,004,701
This Year
Last Year
Net income
$
391,300
$
381,500
Less preferred dividends
48,000
48,000
Net income remaining for common (a)
343,300
333,500
Average total stockholders' equity
3,385,150
4,129,100.5
Less average preferred stock
600,000
600,000
Average common equity (b)
$
2,785,150
$
3,529,100.5
Return on common stockholders' equity (a) ÷ (b)
12.3%
9.5%
c. Leverage is positive for this year because the return on common equity (12.3%) is greater than the return on total assets (9.1%). For last year, leverage is positive because the return on the common equity (9.5%) is greater than the return on total assets (8.1%).
2.
a.
This Year
Last Year
Net income remaining for common [see above] (a)
$
343,300
$
333,500
Average number of common shares outstanding (b)
50,000
50,000
Earnings per share (a) ÷ (b)
$ 6.87
$ 6.67
b.
This Year
Last Year
Dividends per share (a)
$
1.6
$
0.8
Market price per share (b)
$
46.00
$
30.00
Dividend yield ratio (a) ÷ (b)
3.5%
2.7%
c.
This Year
Last Year
Dividends per share (a)
$
1.6
$
0.8
Earnings per share (b)
$
6.87
$
6.67
Dividend payout ratio (a) ÷ (b)
23.3%
12%
d.
This Year
Last Year
Market price per share (a)
$
46
$
30.00
Earnings per share (b)
$
6.87
$
6.67
Price-earnings ratio (a) ÷ (b)
6.7
4.5
e.
This Year
Last Year
Stockholders' equity
$
3,516,800
$
3,253,500
Less preferred stock
600,000
600,000
Common stockholders' equity (a)
$
2,916,800
$
2,653,500
Number of common shares outstanding (b)
50,000
50,000
Book value per share (a) ÷ (b)
$ 58.34
$ 53.07
Note that the book value of Hedrick Company’s stock is greater than its market value for both years. This does not necessarily indicate that the stock is selling at a bargain price. Market value is an indication of investors’ perceptions of future earnings and/or dividends, whereas book value is a result of already completed transactions.
f.
This Year
Last Year
Gross margin (a)
$
1,200,000
$
1,170,000
Sales (b)
$
5,400,000
$
4,330,000
Gross margin percentage (a) ÷ (b)
22.2%
27.0%
3.
This Year
Last Year
a.
Current assets (a)
$
2,607,000
$
2,060,000
Current liabilities (b)
1,350,000
870,000
Working capital (a) – (b)
$
1,257,000
$
1,190,000
b.
Current assets (a)
$
2,607,000
$
2,060,000
Current liabilities (b)
$
1,350,000
$
870,000
Current ratio (a) ÷ (b)
1.9
2.4
c.
Quick assets (a)
$
1,224,000
$
1,122,000
Current liabilities (b)
$
1,350,000
$
870,000
Acid-test ratio (a) ÷ (b)
0.91
1.29
The accounts receivable at the beginning of last year totaled $518,000
d.
Sales on account (a)
$
5,400,000
$
4,330,000
Average receivables (b)
$
751,500
$
559,500
Accounts receivable turnover (a) ÷ (b)
7.2
7.7
Average collection period:
365 days ÷ accounts receivable turnover
51 days
47 days
The inventory at the beginning of last year totaled $660,000.
e.
Cost of goods sold (a)
$
4,200,000
$
3,160,000
Average inventory balance (b)
$
1,095,000
$
770,000
Inventory turnover ratio (a) ÷ (b)
3.8
4.1
Average sale period:
365 days ÷ inventory turnover ratio
96 days
89 days
f.
Total liabilities (a)
$
2,560,000
$
2,020,000
Stockholders' equity (b)
$
3,516,800
$
3,253,500
Debt-to-equity ratio (a) ÷ (b)
0.73
0.62
g.
Net income before interest and income taxes (a)
$
6,80,000
$
660,000
Interest expense (b)
$
121,000
$
115,000
Times interest earned (a) ÷ (b)
5.6
5.7
This Year
Last Year
Net income
$ 391,300
$ 381,500
Add after-tax cost of interest:
$121,000 × (1 – 0.30)
84,700
$115,000 × (1 – 0.30)
80,500
Total (a)
$ 476,000
$ 462,000
Average total assets (b)
$
5,238,400
$
5,675,150
Return on total assets (a) ÷ (b)
9.1%
8.1%
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