Using the following data for Jackson Products Company, answer Parts a through g:
ID: 2721941 • Letter: U
Question
Using the following data for Jackson Products Company, answer Parts a through g: Jackson Products Company’s Balance Sheet December 31, 2013 Cash $ 240,000 Accounts payable $ 380,000 Accounts receivable 320,000 Notes payable (9%) 420,000 Inventory 1,040,000 Other current liabilities 50,000 Total current assets $1,600,000 Total current liabilities $ 850,000 Net plant and 800,000 Long-term debt (10%) 800,000 equipment Total assets $2,400,000 Stockholders’ equity 750,000 Total liabilities and stockholders’ equity $2,400,000 Income Statement for the Year Ended December 31, 2013 Net sales (all on credit) $3,000,000 Cost of sales 1,800,000 Gross profit $1,200,000 Selling, general, and administrative expenses 860,000 Earnings before interest and taxes $340,000 Interest: Notes $37,800 Long-term debt 80,000 Total interest charges 117,800 Earnings before taxes $222,200 Federal income tax (40%) 88,880 Earnings after taxes $133,320 Industry Averages Current ratio 2.5:1 Quick ratio 1.1:1 Average collection period (365-day year) 35 days Inventory turnover ratio 2.4 times Total asset turnover ratio 1.4 times Times interest earned ratio 3.5 times Net profit margin ratio 4.0% Return on investment ratio 5.6% Total assets/stockholders’ equity (equity multiplier) ratio 3.0 times Return on stockholders’ equity ratio 16.8% P/E ratio 9.0 times a. Evaluate the liquidity position of Jackson relative to that of the average firm in the industry. Consider the current ratio, the quick ratio, and the net working capital (current assets minus current liabilities) for Jackson. What problems, if any, are suggested by this analysis? b. Evaluate Jackson’s performancebylookingatkeyassetmanagementratios.Are any problems apparent from this analysis? c. Evaluate the financial risk of Jackson by examining its times interest earned ratio and its equity multiplier ratio relative to the same industry average ratios. d. Evaluate the profitability of Jackson relative to that of the average firm in its industry. e. Give an overall evaluation of the performance of Jackson relative to other firms in its industry. f. Perform a DuPont analysis for Jackson. What areas appear to have the greatest need for improvement? g. Jackson’s currentP/Eratiois7times.Whatfactor(s)aremostlikelytoaccount for this ratio relative to the higher industry average ratio?
Explanation / Answer
a. Jackson’s current ratio is 1.88x compared to the industry average of 2.5 times. Jackson’s quick ratio is 0.66x compared to an industry average of 1.1x. Jackson has net working capital of $750,000. Jackson’s liquidity is considerably below that of the industry average. Based on a comparison of the firm’s current ratio to that of the industry and the firm’s quick ratio to that of the industry, there is some evidence that Jackson may carry excessive or slow moving inventory.
b. The company has an average collection period of 38.9 days compared to an industry average of 35 days. The company’s inventory turnover ratio is only 1.73x compared to an industry average of 2.4x. This provides additional evidence of Jackson’s potential inventory problems. Finally, Jackson’s total asset turnover ratio of 1.25x is below the industry average of 1.4x, probably because of the inventory problems and the slightly higher than average receivables balance.
c. The company’s times interest earned ratio is 2.89x compared to the industry average of 3.5x. The company’s total assets to stockholders’ equity ratio is 3.2x compared to the industry average of 3.0x. This slightly higher amount of financial leverage and significantly lower interest coverage ratio suggest that Jackson either pays very high interest charges relative to other firms, is less profitable than the average firm or a combination of both. In any case the firm appears to have more financial risk than the average firm.
d. Jackson’s net profit margin of 4.44% exceeds the industry average of 4.0%. The company’s return on investment of 5.56% is only slightly below the industry average of 5.6%. Jackson’s return on stockholders’ equity of 17.78% exceeds the industry average of 16.8% because of the higher level of financial leverage used by Jackson.
e. Jackson seems to be carrying excessive inventory, resulting in a lower asset turnover. The company’s liquidity position is also weak (quick ratio). In spite of these areas for potential improvement, the firm has outperformed the average firm in the industry and has assumed more financial risk in doing this.
f. ROE = Net profit margin times Total asset turnover times Equity multiplier
ROE = ($133,320/$3,000,000) x ($3,000,000/$2,400,000) x ($2,400,000/$750,000)
ROE = 0.1778 or 17.8%
The primary area for improvement is total asset turnover (especially inventories).
g. The biggest factor that can explain Jackson’s lower P/E ratio relative to the industry average is the higher amount of financial risk the firm possesses. ,Also, Jackson could be perceived as having a lower growth potential than the average firm, although there is no direct evidence presented in the data to indicate this.
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