Question

Paul Sabin organized Sabin Electronics 10 years ago to produce and sell several electronic devices on...

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 $640,000 long-term loan from Gulfport State Bank, $170,000 of which will be used to bolster the Cash account and $470,000 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 $ 126,000 $ 290,000
Marketable securities 0 11,000
Accounts receivable, net 659,000 440,000
Inventory 1,020,000 735,000
Prepaid expenses 34,000 36,000
Total current assets 1,839,000 1,512,000
Plant and equipment, net 2,084,600 1,470,000
Total assets $ 3,923,600 $ 2,982,000
Liabilities and Stockholders Equity
Liabilities:
Current liabilities $ 870,000 $ 440,000
Bonds payable, 12% 800,000 800,000
Total liabilities 1,670,000 1,240,000
Stockholders' equity:
Common stock, $20 par 830,000 830,000
Retained earnings 1,423,600 912,000
Total stockholders’ equity 2,253,600 1,742,000
Total liabilities and stockholders' equity $ 3,923,600 $ 2,982,000
Sabin Electronics
Comparative Income Statement and Reconciliation
This Year Last Year
Sales $ 5,700,000 $ 4,770,000
Cost of goods sold 4,015,000 3,590,000
Gross margin 1,685,000 1,180,000
Selling and administrative expenses 681,000 576,000
Net operating income 1,004,000 604,000
Interest expense 96,000 96,000
Net income before taxes 908,000 508,000
Income taxes (30%) 272,400 152,400
Net income 635,600 355,600
Common dividends 124,000 103,000
Net income retained 511,600 252,600
Beginning retained earnings 912,000 659,400
Ending retained earnings $ 1,423,600 $ 912,000

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 $60 per share; last year it sold for $55 per share.

c. The dividend payout ratio.

d. The price-earnings ratio. (Assume that the industry norm for the price-earnings ratio is 7)

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 $2,942,000.)

d. The return on equity. (Stockholders’ equity at the beginning of last year was $1,732,000.)

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

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Answer #1
earnings per share net income / no.of shares outstanding
this year ($) last year ($)
net income 635600 355600
no.of shares outstanding 41500 41500
earnings per share 15.32 8.57
dividend yield ratio dividend per share / price per share
this year ($) last year ($)
dividend 124000 103000
no.of shares outstanding 41500 41500
dividend per share 2.99 2.48
price per share 60 55
dividend yield ratio 4.98% 4.51%
dividend payout ratio dividend per share / earnings per share
this year ($) last year ($)
dividend per share 2.99 2.48
earnings per share 15.32 8.57
dividend payout ratio 19.52% 28.94%
price-earnings ratio market value per share / earnings per share
this year ($) last year ($)
market value per share 60 55
earnings per share 15.32 8.57
price-earnings ratio 3.92 6.42
book value per share of common stock (stockholders equity-preferred equity) / no.of common shares
this year ($) last year ($)
stockholders equity 2253600 1742000
no.of shares outstanding 41500 41500
book value per share of common stock 54.30 41.98
gross margin percentage (gross profit / sales)*100
this year ($) last year ($)
gross profit 1685000 1180000
sales 5700000 4770000
gross margin percentage 29.56% 24.74%
net profit margin percentage (net profit / sales)*100
this year ($) last year ($)
net income 635600 355600
sales 5700000 4770000
net profit margin percentage 11.15% 7.45%
return on total assets EBIT / average total assets
this year ($) last year ($)
EBIT 1004000 604000
opening total assets 2982000 2942000
closing total assets 3923600 2982000
average total assets 3452800 2962000
return on total assets 29.08% 20.39%
return on equity net income / average shareholders equity
this year ($) last year ($)
net income 635600 355600
opening shareholders equity 1742000 1732000
closing shareholders equity 2253600 1742000
average shareholders equity 1997800 1737000
return on equity 31.81% 20.47%
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