You have just been hired as a loan officer at San Diego State Bank. Your supervi

ID: 2532512 • Letter: Y

Question

You have just been hired as a loan officer at San Diego State Bank. Your supervisor has given you a file containing a request from Mobile 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:

Loretta Young, who just two years ago was appointed president of Mobile Company, admits that the company has been “inconsistent” in its performance over the past several years. But Young argues that the company has its costs under control and is now experiencing strong sales growth, as evidenced by the more than 27% increase in sales over the last year. Young also argues that investors have recognized the improving situation at Mobile Company, as shown by the jump in the price of its common stock from $47.00 per share last year to $57.00 per share this year. Young 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 Mobile’s industry:

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 $4,390,000.) (Round your percentage answers to 1 decimal place i.e., 0.123 is considered as 12.3.)

The return on common stockholders’ equity. (Stockholders' equity at the beginning of last year totaled $4,519,185. There has been no change in preferred or common stock over the last two years.) (Do not round your intermediate calculations. Round your percentage answers to 1 decimal place i.e., 0.123 is considered as 12.3.)

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.)

The dividend yield ratio for common stock. (Round your intermediate calculations to 2 decimal places and and your percentage answers to 1 decimal place i.e., 0.123 is considered as 12.3.)

The dividend payout ratio for common stock. (Round your intermediate calculations to 2 decimal places and your percentage answers to 1 decimal place i.e., 0.123 is considered as 12.3.)

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.)

The gross margin percentage. (Round your percentage answers to 1 decimal place i.e., 0.123 is considered as 12.3.)

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 $520,000.) (Use 365 days in a year. Do not round intermediate calculations. Round your final answers to the nearest whole number.)

The average sale period. (The inventory at the beginning of last year totaled $650,000.) (Use 365 days in a year. Round your intermediate calculations to 2 decimal and final answers to the nearest whole number.)

Explanation / Answer

Part 1:

This year

Last year

Return on total assets

Net income

486150

325150

Average total assets

Opening assets

5049150

4390000

Add: Closing total assets

6114300

5049150

11163450

9439150

Average total assets (opening assets + closing assets) / 2

5581725

4719575

Return on total assets (Net income x 100/ Average total assets )

8.7096731

6.889392

b. The return on common shareholders' equity

Net income

486150

325150

Less: Preferred dividend

48000

Earnings available to the common shareholders

438150

277150

Average common share holders' equity

Opening common shareholders' equity

3177150

4519185

Add: Closing common shareholders' equity

3530300

3177150

6707450

7696335

Average common share holders' equity (Opening equity + closing equity) /2

3353725

3848168

b. The return on common shareholders' equity (Earnings available to common shareholders x 100/ Average equity)

13.064577

7.202129

c. Degree of financial leverage

Net income before interest and taxes

830000

580000

Net income before taxes

694500

464500

Degree of financial leverage (EBIT / EBIT - Interest)

1.1951044

1.248654

Yes, company's financial leverage is positive

Part 2:

This year

Last year

a. Earnings per share

Net income

486150

325150

Less: Preferred dividend

48000

(A): Earnings available to the common shareholders

438150

277150

(B): Number of common shares

50000

(2000000 / 40)

EPS (A/ B)

8.763

5.543

b. Dividend yield ratio for common stock

(A): Dividend paid to common shareholders

85000

61000

Average common share holders' equity

Opening common shareholders' equity

3177150

4519185

Add: Closing common shareholders' equity

3530300

3177150

6707450

7696335

(B): Average common share holders' equity (Opening equity + closing equity) /2

3353725

3848168

Dividend yield (A x 100/B)

2.5344952

1.58517

c. Dividend pay-out ratio for common stock

(A): Dividend paid to common shareholders

85000

61000

Net income

486150

325150

Less: Preferred dividend

48000

(B): Earnings available to the common shareholders

438150

277150

Dividend pay-out ratio for common stock (A x 100/B)

19.399749

22.00974

d. Price earnings ratio

(A): Market price per share

(B): EPS

EPS

8.763

5.543

Price earnings ratio (A/B)

6.5046217

8.479163

e. The books value of per share of common stock

(A): Common stockholders' equity

3530300

3177150

(B): Number of common shares

50000

Book value per share (A/B)

70.606

63.543

f. The gross margin percentage

(A): Turnover / sales

5490000

4310000

(B): Gross profit

1375000

1105000

Gross margin percentage (B X 100 / A)

25.045537

25.63805

Part 3:

This year

Last year

a. Working capital (Current assets - Current liabilities)

Total current assets

2663500

1942750

Less: Total current liabilities

1274000

762000

Working capital

1389500

1180750

b. Current ratio

Current assets

2663500

1942750

Current liabilities

1274000

762000

Current ratio (CA/CL)

2.0906593

2.549541

c. Acid test ratio

Current assets

2663500

1942750

Less: inventories

1352500

752500

(A): Current assets less inventories

1311000

1190250

(B): Current liabilities

1274000

762000

Acid test ratio (A/B)

1.0290424

1.562008

d. The average collection period (AR 520000)

Average accounts receivable:

Opening accounts receivable

637000

520000

Add: Closing accounts receivable

934000

637000

Opening plus closing accounts receivable

1571000

1157000

(A):Average accounts receivable:

785500

578500

(B): Sales

5490000

4310000

Average collection period in days (A x 365 /B)

52.223588

48.9913

e. Average sales period with inventory 650000

Average inventory:

Opening inventory

752500

650000

Add: Closing inventory

1352500

752500

2105000

1402500

(A): Average inventory (Opening plus closing inventory / 2)

1052500

701250

(B): Sales

5490000

4310000

e. Average sales period with inventory (A x 365/B)

69.974954

59.3866

Debt to equity

(A): Debt fund

1310000

1110000

(B): Equity funds

3530300

3177150

Debt to equity (A/B)

0.3710733

0.34937

g. The times interest earned

Net income

486150

325150

Add: Interest expense

135500

115500

(A): Net income plus interest

621650

440650

(B): Interest expenses

135500

115500

The times interest earned (A/B)

4.5878229

3.815152

Part 1:

This year

Last year

Return on total assets

Net income

486150

325150

Average total assets

Opening assets

5049150

4390000

Add: Closing total assets

6114300

5049150

11163450

9439150

Average total assets (opening assets + closing assets) / 2

5581725

4719575

Return on total assets (Net income x 100/ Average total assets )

8.7096731

6.889392

b. The return on common shareholders' equity

Net income

486150

325150

Less: Preferred dividend

48000

Earnings available to the common shareholders

438150

277150

Average common share holders' equity

Opening common shareholders' equity

3177150

4519185

Add: Closing common shareholders' equity

3530300

3177150

6707450

7696335

Average common share holders' equity (Opening equity + closing equity) /2

3353725

3848168

b. The return on common shareholders' equity (Earnings available to common shareholders x 100/ Average equity)

13.064577

7.202129

c. Degree of financial leverage

Net income before interest and taxes

830000

580000

Net income before taxes

694500

464500

Degree of financial leverage (EBIT / EBIT - Interest)

1.1951044

1.248654

Yes, company's financial leverage is positive

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