Quiz

1. Liquidity ratios.

Edison, Stagg, and Thornton have the following financial information at the close of business on July 10:

Edison Stagg  Thornton

Cash    4,000  2,500  1,000

Short-term investments           3,000  2,500  2,000

Accounts receivable    2,000  2,500  3,000

Inventory        1,000  2,500  4,000

Prepaid expenses         800      800      800

Accounts payable        200      200      200

Notes payable: short-term       3,100  3,100  3,100

Accrued payables        300      300      300

Long-term liabilities    3,800  3,800  3,800

a. Compute the current and quick ratios for each of the three companies. (Round calculations to two decimal places.) Which firm is the most liquid? Why?

b. SupposeThorntonis using FIFO for inventory valuation andEdisonis using LIFO. Comment on the comparability of information between these two companies.

c. If all short-term notes payable are due on July 11 at 8 a.m., comment on each company’s ability to settle its obligation in a timely manner.

2. Computation and evaluation of activity ratios.

The following data relate to Alaska Products, Inc:

19X5   19X4

Net credit sales           832,000           760,000

Cost of goods sold      440,000           350,000

Cash, Dec. 31  125,000           110,000

Accounts receivable, Dec. 31 180,000           140,000

Inventory, Dec. 31      70,000 50,000

Accounts payable, Dec. 31     115,000           108,000

The company is planning to borrow $300,000 via a 90-day bank loan to cover short-term operating needs.

a. Compute the accounts receivable and inventory turnover ratios for 19X5.Alaskarounds all calculations to two decimal places.

b. Study the ratios from part (a) and comment on the company’s ability to repay a bank loan in 90 days.

c. Suppose that Alaska’s major line of business involves the processing and distribution of fresh and frozen fish throughout theUnited States. Do you have any concerns about the company’s inventory turnover ratio? Briefly discuss.

3.  Profitability ratios, trading on the equity.

Digital Relay has both preferred and common stock outstanding. The com­pany reported the following information for 19X7:

Net sales          1,500,000

Interest expense          120,000

Income tax expense    80,000

Preferred dividends    25,000

Net income      130,000

Average assets            1,100,000

Average common stockholders’ equity           400,000

a.  Compute the profit margin on sales and the rates of return on assets and common stockholders’ equity, rounding calculations to two decimal places.

b.  Does the firm have positive or negative financial leverage? Briefly explain.

4.   Financial statement construction via ratios.

Incomplete financial statements of Lock Box, Inc., are presented below.

LOCK BOX, INC.

Income Statement

For the Year Ended December 31, 19X3

Sales    $ ?

Cost of goods sold      ?

Gross profit     15,000,000

Operating expenses & interest            ?

Income before tax       $ ?

Income taxes, 40%      ?

Net income      $ ?

LOCK BOX, INC.

Balance Sheet

December 31, 19X3

Assets

Cash    $ ?

Accounts receivable    ?

Inventory        ?

Property, plant, &. equipment 8,000,000

Total assets 24,000,000

Liabilities & Stockholders’ Equity

Accounts payable        $ ?

Notes payable (short-term)     600,000

Bonds payable            4,600,000

Common stock            2,000,000

Retained earnings       ?

Total liabilities & stockholders’ equity       24,000,000

Further information:

Cost of goods sold is 60% of sales. All sales are on account.

The company’s beginning inventory is $5 million; inventory turnover is 4.

The debt to total assets ratio is 70%.

The profit margin on sales is 6%.

The firm’s accounts receivable turnover is 5. Receivables increased by $400,000 during the year.

Instructions:

Using the preceding data, complete the income statement and the balance sheet.

 

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