10 Jan 1. Return on sales

Question 1 (1 point) Question 1 Unsaved

The following information is computed from Fast Food Chain’s annual report for 2012.

2012

2011

Current assets

$ 2,731,020

$ 2,364,916

Property and equipment, net

10,960,286

8,516,833

Intangible assets, at cost less applicable

amortization

294,775

255,919

$13,986,081

$11,137,668

Current liabilities

$ 3,168,123

$ 2,210,735

Deferred federal income taxes

160,000

26,000

Mortgage note payable

456,000

–

Stockholders’ equity

10,201,958

8,900,933

$13,986,081

$11,137,668

Net sales

$33,410,599

$25,804,285

Cost of goods sold

(30,168,715)

(23,159,745)

Selling and administrative expense

(2,000,000)

(1,500,000)

Interest expense

(216,936)

(39,456)

Income tax expense

(400,000)

(300,000)

Net income

$ 624,948

$ 805,084

Note: One-third of the operating lease rental charge was $100,000 in 2012 and $50,000 in 2011. Capitalized interest totaled $30,000 in 2012 and $20,000 in 2011.

a.

Based on the above data for both years, compute:

1.

Times interest earned

2.

Fixed charge coverage

3.

Debt ratio

4.

Debt/equity ratio

5.

Debt to tangible net worth

b.

Comment on the firm’s long-term borrowing ability based on the analysis.

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Question 2 (1 point) Question 2 Unsaved

Company P had the following capital structure at year-end after closing.

6% Bonds

$10,000,000

3% Preferred Stock

20,000,000

Common Stock ($10 par)

10,000,000

Paid-In Capital in Excess of Par

15,000,000

Retained Earnings

35,000,000

a.

The return on common equity was 9%. Determine the net income assuming common stock dividends were declared and paid.

b.

Using your answer in (a), compute return on investment. Assume that the bond interest is the only interest expense and the tax rate is 50%. Use year-end balance sheet figures.

c.

Compute basic earnings per share. Assume the same number of common shares throughout the whole year.

d.

Compute book value per share.

e.

If the market value is $78, compute the price/earnings ratio using your answer to (c).

f.

Would you expect the market price to be higher than the book value per share?

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Question 3 (1 point) Question 3 Unsaved

The following statements are presented for Melvin Company.

Melvin Company

Balance Sheet

December 31, 2012, and 2011

Assets

2012

2011

Cash

$ 625

$ 499

Marketable securities

260

370

Trade accounts receivable, less allowances of 36 in 2012

and 18 in 2011

1,080

820

Inventories, FIFO

930

870

Prepaid expenses

230

220

Total current assets

$3,125

$2,779

Investments

$ 820

$ 600

Property, plant, and equipment:

Land

$ 130

$ 127

Buildings and improvements

760

670

Machinery and equipment

2,100

1,400

$2,990

$2,197

Less allowances for depreciation

1,100

890

$1,890

$1,307

Goodwill

500

550

Total assets

$6,335

$5,236

Liabilities and Shareholders’ Equity

Accounts payable

$1,200

$ 900

Accrued payroll

100

80

Accrued taxes

300

200

Total current liabilities

$1,600

$1,180

Long-term debt

900

750

Deferred income taxes

300

280

Shareholders’ equity:

Common stock

1,000

1,000

Retained earnings

2,535

2,026

Total liabilities and shareholders’ equity

>

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Question 4 (1 point) Question 4 Unsaved

ABC Company has been a wholesale distributor of automobile parts for domestic automakers for 20 years. ABC has suffered through the recent slump in the domestic auto industry, and its performance has not rebounded to the levels of the industry as a whole. ABC’s single-step income statement for the year ended November 30, 2011 follows:

ABC Company

Income Statement

For the Year Ended November 30, 2011 (thousands omitted)

Net sales $8,400

Expenses:

Cost of goods sold 6,300

Selling expense 780

Administrative expense 900

Interest expense 140

Total 8,120

Income before income taxes 280

Income taxes 112

Net income $ 168

ABC’s return on sales before interest and taxes was 5% in fiscal year 2011 compared with the industry average of 9%. ABC’s turnover of average assets of four times per year and return on average assets before interest and taxes of 20% are both well below the industry average.

Joe Kuhn, president of ABC, wishes to improve these ratios and raise them nearer to the industry averages. He established the following goals for ABC Company for fiscal year 2012:

Return on sales before interest and taxes 8%

Turnover of average assets 5 times per year

Return on average assets before interest and taxes 30%

For fiscal 2012, Kuhn and the rest of ABC’s management team are considering the following actions, which they expect will improve profitability and result in a 5% increase in unit sales:

1. Increase selling price 10%.

2. Increase advertising by $420,000 and hold all other selling and administrative expenses at

fiscal 2011 levels.

3. Improve customer service by increasing average current assets (inventory and accounts

receivable) by a total of $300,000, and hold all other assets at fiscal 2011 levels.

4. Finance the additional assets at an annual interest rate of 10% and hold all other interest

expense at fiscal 2011 levels.

5. Improve the quality of products carried; this will increase the units of goods sold by 4%.

6. ABC’s 2012 effective income tax rate is expected to be 40% – the same as in fiscal 2011.

a. Prepare a single-step pro forma income statement for ABC Company for the year ended

November 30,2012, assuming that ABC’s planned actions would be carried out and that the

5% increase in unit sales would be realized.

b. Calculate the following ratios for ABC Company for the 2011-2012 fiscal year and state

whether Kuhn’s goal would be achieved:

1. Return on sales before interest and taxes.

2. Turnover of average assets.

3. Return on average assets before interest and taxes.

4. Would it be possible for ABC Company to achieve the first two of Kuhn’s goals without

achieving his third goal of 30% return on average assets before interest and taxes? Explain

your answer.

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