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Horngren'S Financial And Managerial Accounting
Found in: Page 845

Short Answer

Using ratios to evaluate a stock investment

Comparative financial statement data of Sanfield, Inc. follow:

SANFIELD, INC.

Comparative Income Statement

Years Ended December 31, 2018, and 2017

2018

2017

Net Sales Revenue

$ 462,000

$ 430,000

Cost of Goods Sold

236,000

213,000

Gross Profit

226,000

217,000

Operating Expense

135,000

133,000

Income from Operations

91,000

84,000

Interest Expense

8,000

12,000

Income Before Income Tax

83,000

72,000

Income Tax Expense

18,000

22,000

Net Income

$ 65,000

$ 50,000

SANFIELD, INC.

Comparative Balance Sheet

December 31, 2018, and 2017

2018

2017

2016

Asset

Current Assets:

Cash

$ 99,000

$ 97,000

Accounts Receivable, Net

109,000

117,000

$ 100,000

Merchandise Inventory

142,000

164,000

207,000

Prepaid Expenses

15,000

5,000

Total Current Assets

365,000

383,000

Property, Plant, and Equipment, Net

215,000

177,000

Total Assets

$ 580,000

$ 560,000

$ 599,000

Liabilities

Total Current Liabilities

$ 222,000

$ 244,000

Long-term Liabilities

113,000

92,000

Total Liabilities

335,000

336,000

Stockholders’ Equity

Preferred Stock, 4%

92,000

92,000

Common Stockholders’ Equity, no par

153,000

132,000

85,000

Total Liabilities and Stockholders’ Equity

$ 580,000

$ 560,000

1. Market price of Sanfield’s common stock: $51.48 at December 31, 2018, and $37.08 at December 31, 2017.

2. Common shares outstanding: 16,000 on December 31, 2018 and 15,000 on December 31, 2017 and 2016.

3. All sales are on credit.

Requirements

1. Compute the following ratios for 2018 and 2017:

  1. Current ratio
  2. Cash ratio
  3. Times-interest-earned ratio
  4. Inventory turnover
  5. Gross profit percentage
  6. Debt to equity ratio
  7. Rate of return on common stockholders’ equity
  8. Earnings per share of common stock
  9. Price/earnings ratio

2. Decide (a) whether Sanfield’s ability to pay debts and sell inventory improved or deteriorated during 2018 and (b) whether the investment attractiveness of its common stock appears to have increased or decreased.

S. no.

2018

2017

1

a.

1.64

1.57

b.

0.45

0.39

c.

11.38

7.00

d.

1.54

1.15

e.

48.9%

50.5%

f.

1.37

1.50

g.

43.0%

42.7%

h.

$3.96

$3.09

i.

13.0

12.0

2

a.The company's capacity to sell inventory increased as the inventory turnover improved.
b.The desirability of Sanfield's stock increased in 2018.
See the step by step solution

Step by Step Solution

Step 1: Meaning of Ratio Analysis

Ratio analysis is a fundamental approach to assessing a company's health by examining the relationships between key financial indicators. According to many analysts, ratio analysis is the most critical aspect of the analytical process.

Step 2: (1) Computing ratios

a). Current ratio

2018

2017

b) Cash ratio

2018

2017

c) Times interest earned ratio

2018

2017

d) Inventory turnover ratio

2018

2017

e) Gross profit percentage

2018

2017

f) Debt to equity ratio

2018

2017

g) Rate of return on common stockholder’s equity

2018

2017

h) Earnings per share of common stock

2018

2017

i) Price/earnings ratio

2018

2017

Step 3: (2) Explaining the situation of Sanfield’s

  1. Compared to 2017, Sanfield is better positioned to pay off the debt in 2018. The times-interest-earned ratio, cash ratio, and current ratio all increased. The company's capacity to sell inventory increased as the inventory turnover improved.
  2. 2018 has seen an improvement in Sanfield's stock's appeal. The earnings per share and price/earnings ratio increased with the rate of return on common stockholders' equity.

Most popular questions for Business-studies Textbooks

Completing a comprehensive financial statement analysis

In its annual report, ABC Athletic Supply, Inc. includes the following five-year financial summary:

ABC ATHLETIC SUPPLY, INC.Five-Year Financial Summary (Partial; adapted)

(Dollar amounts in thousands except per share data)

2018

2017

2016

2015

2014

2013

Net Sales Revenue

$250,000

$216,000

$191,000

$161,000

$134,000

Net Sales Revenue Increase

16%

13%

19%

20%

17%

Domestic Comparative Store Sales Increase

5%

6%

4%

7%

9%

Other Income—Net

2,110

1,840

1,760

1,690

1,330

Cost of Goods Sold

189,250

164,592

148,216

126,385

106,396

Selling and Administrative Expenses

41,210

36,330

31,620

27,440

22,540

Interest:

Interest Expense

(1,080)

(1,380)

(1,400)

(1,020)

(830)

Interest Income

125

165

155

235

190

Income Tax Expense

4,470

3,900

3,700

3,320

2,700

Net Income

16,225

11,803

7,979

4,760

3,054

Per Share of Common Stock:

Net Income

1.60

1.30

1.20

1.00

0.78

Dividends

0.40

0.38

0.34

0.30

0.26

Financial Position

Current Assets, Excluding Merchandise Inventory

$30,700

$27,200

$26,700

$24,400

$21,500

Merchandise Inventory

24,500

22,600

21,700

19,000

17,500

$16,700

Property, Plant, and Equipment, Net

51,400

45,200

40,000

35,100

25,600

Total Assets

106,600

95,000

88,400

78,500

64,600

Current Liabilities

32,300

28,000

28,300

25,000

16,500

Long-term Debt

23,000

21,500

17,600

19,100

12,000

Stockholders’ Equity

51,300

45,500

42,500

34,400

36,100

Financial Ratios

Acid-Test Ratio

1.0

1.0

0.9

1.0

1.3

Rate of Return on Total Assets

17.2%

14.4%

11.2%

8.1%

7.1%

Rate of Return on Common Stockholders’ Equity

35.5%

26.%

20.8%

13.5%

13.0%

Requirements

Analyze the company’s financial summary for the fiscal years 2014–2018 to decide whether to invest in the common stock of ABC. Include the following sections in your analysis.

  1. Trend analysis for net sales revenue and net income (use 2014 as the base year).
  2. Profitability analysis.
  3. Evaluation of the ability to sell merchandise inventory.
  4. Evaluation of the ability to pay debts.
  5. Evaluation of dividends.
  6. Should you invest in the common stock of ABC Athletic Supply, Inc.? Fully explain your final decision
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