Question

Paul Sabin organized Sabin Electronics 10 years ago to produce and sell several electronic devices on which he had secured patents. Although the company has been fairly profitable, it is now experiencing a severe cash shortage. For this reason, it is requesting a $530,000 long-term loan from Gulfport State Bank, $115,000 of which will be used to bolster the Cash account and $415,000 of which will be used to modernize equipment. The company’s financial statements for the two most recent years follow:

Sabin Electronics
Comparative Balance Sheet
	This Year		Last Year
Assets
Current assets:
Cash	$	82,000	$	180,000
Marketable securities		0		21,000
Accounts receivable, net		516,000		330,000
Inventory		980,000		625,000
Prepaid expenses		22,000		25,000
Total current assets		1,600,000		1,181,000
Plant and equipment, net		1,570,200		1,400,000
Total assets	$	3,170,200	$	2,581,000
Liabilities and Stockholders Equity
Liabilities:
Current liabilities	$	815,000	$	460,000
Bonds payable, 12%		750,000		750,000
Total liabilities		1,565,000		1,210,000
Stockholders' equity:
Common stock, $15 par		720,000		720,000
Retained earnings		885,200		651,000
Total stockholders’ equity		1,605,200		1,371,000
Total liabilities and stockholders' equity	$	3,170,200	$	2,581,000

Sabin Electronics
Comparative Income Statement and Reconciliation
	This Year		Last Year
Sales	$	5,150,000	$	4,440,000
Cost of goods sold		3,905,000		3,480,000
Gross margin		1,245,000		960,000
Selling and administrative expenses		659,000		554,000
Net operating income		586,000		406,000
Interest expense		90,000		90,000
Net income before taxes		496,000		316,000
Income taxes (30%)		148,800		94,800
Net income		347,200		221,200
Common dividends		113,000		92,000
Net income retained		234,200		129,200
Beginning retained earnings		651,000		521,800
Ending retained earnings	$	885,200	$	651,000

During the past year, the company introduced several new product lines and raised the selling prices on a number of old product lines in order to improve its profit margin. The company also hired a new sales manager, who has expanded sales into several new territories. Sales terms are 3/10, n/30. All sales are on account.

Assume Paul Sabin has asked you to assess his company’s profitability and stock market performance.

Required:

1. You decide first to assess the company’s stock market performance. For both this year and last year, compute:

a. The earnings per share. There has been no change in common stock over the last two years.

b. The dividend yield ratio. The company’s stock is currently selling for $55 per share; last year it sold for $50 per share.

c. The dividend payout ratio.

d. The price-earnings ratio. (Assume that the industry norm for the price-earnings ratio is 10)

e. The book value per share of common stock.

2. You decide next to assess the company’s profitability. Compute the following for both this year and last year:

a. The gross margin percentage.

b. The net profit margin percentage.

c. The return on total assets. (Total assets at the beginning of last year were $2,390,000.)

d. The return on equity. (Stockholders’ equity at the beginning of last year was $1,361,000.)

e. Is the company’s financial leverage positive or negative?

Answer 1

This Year Last Year a Earnings Per Share Net Earnings Available for Common Stock Average Outstanding Common Shares 347200 221200 (720000) /15 (720000) /15 347200 48000 221200 48000 Earnings Per Share 7.23 4.61 b Dividend Yield Ratio Dividend Per Share Market Price Per Share 113000/48000 92000/48000 55 2.35 55 1.92 50 Dividend Yield 4.3% 3.8% = c Dividend Payout Ratio Dividend Per Share Earnings Per Share 2.35 7.23 1.92 4.61 Dividend Payout Ratio = 32.5% 41.6%

d Price Earning Ratio Market Price Per Share Earnings Per Share 55 7.23 4.61 Price Earning Ratio 7.60 10.85 e Book Value Per Share Shareholder's Equity Outstanding Common Shares 1605200 48000 1371000 48000 Book Value Per Share 33.44 28.56 a Gross Profit % Gross Profit Net Sales 1245000 5150000 960000 4440000 Gross Profit % 24.2% 21.6% b Net Profit % Net Profit Net Sales 347200 5150000 221200 4440000 Net Profit % 6.7% 5.0%

c Return on Assets Net Income Average Total Assets (347200+(90000*(1-.30)) (3170200+2581000)/2 (221200+(90000*(1-.30)) (2581000+2390000)/2 410200 2875600 284200 2485500 Return on Assets 14.3% 11.4% d Return on Common stockholder's Equity Net Income Average Total Stockholder's Equity 347200 221200 (1605200+1371000)/2 (1371000+1361000)/2 347200 1488100 221200 1366000 Return on Equity 23.3% 16.2% e Financial leverage is positive as the return on commonstockholder's equity is greater than the return on assets