Question

Required information [The following information applies to the questions displayed below.] You have just been hired as a financial analyst for Lydex Company, a manufacturer of safety helmets. Your boss has asked you to perform a comprehensive analysis of the company's financial statements, including comparing Lydex's performance to its major competitors. The company's financial statements for the last two years are as follows: Lydex Company Comparative Balance Sheet This Year Last Year $ 980,000 2,780,000 3,620,000 260,000 7,640,000 9,560, 000 $17,200,000 $1,220,000 300,000 1,880,000 2,200,000 200,000 5,800,000 9,070,000 $14,870,000 Assets Current assets: Cash Marketable securities Accounts receivable, net Inventory Prepaid expenses Total current assets Plant and equipment, net Total assets Liabilities and Stockholders' Equity Liabilities: Current liabilities Note payable, 10% Total liabilities Stockholders' equity: Common stock, $75 par value Retained earnings Total stockholders' equity Total liabilities and stockholders' equity $ 4,030,000 3,680,000 7,710,000 $ 3,020,000 3,080,000 6,100,000 7,500,000 1,990,000 9,490,000 $17, 200,000 7,500,000 1,270,000 8,770,000 $14,870,000 Lydex Company Comparative Income Statement and Reconciliation This Year Last Year Sales (all on account) $ 15,880,000 $ 13,780,000 Cost of goods sold 12,704,000 10, 335,000 Gross margin 3,176,000 3, 445,000 Selling and administrative expenses 1, 208,000 1,612,000 Net operating income 1,968,000 1,833,000 Interest expense 368,000 308,000 Net income before taxes 1,600,000 1,525,000 Income taxes (30%) 480,000 457,500 Net income 1,120,000 1,067,500 Common dividends 400,000 533,750 Net income retained 720,000 533, 750 Beginning retained earnings 1,270,000 736,250 Ending retained earnings $ 1,990,000 $ 1,270,000 To begin your assignment you gather the following financial data and ratios that are typical of companies in Lydex Company's industry:

Answer 1

Ans. 1
Ans. A	Time interest earned = Net operating income / Interest expenses
	This year	$1,968,000 / $368,000	5.35	times
	Last year	$1,833,000 / $308,000	5.95	times
Ans. B	Debt to equity ratio   =   Total liabilities / Total stockholder's equity
	This year	$7,710,000 / $9,490,000	0.81
	Last year	$6,100,000 / $8,770,000	0.70
Ans. C	Gross margin percentage = Gross margin / Net sales * 100
	This year	$3,176,000 / $15,880,000 * 100	20.0%
	Last year	$3,445,000 / $13,780,000 * 100	25.0%
Ans. D	Return on assets =   Net income / Average assets * 100
	This year	$1,120,000 / $16,035,000 * 100	7.0%
	Last year	$1,067,500 / $13,980,000 * 100	7.6%
	*Average assets = (Beginning assets + Ending assets) / 2
	This year	($14,870,000 + $17,200,000) / 2	$16,035,000
	Last year	($13,090,000 + $14,870,000) / 2	$13,980,000
Ans. E	Return on Common stockholder's equity =   Net income / Average Common stockholder's equity * 100
	This year	$1,120,000 / $9,130,000 * 100	12.3%
	Last year	$1,067,500 / $8,503,125 * 100	12.6%
	* Average Stockholder's equity =   (Beginning equity + Ending equity) / 2
	This year	($8,770,000 + $9,490,000) / 2	$9,130,000
	Last year	($8,236,250 + $8,770,000) / 2	$8,503,125
Ans. F	This year	Positive
	Last year	Positive
	Explanations: The return on equity is greater than the return on assets, so the
	financial leverage is positive in both years.
	Return on equity > Return on assets = Positive financial leverage
	Return on equity < Return on assets = Negative financial leverage