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 $580,000 long-term loan from Gulfport State Bank, $140,000 of which will be used to bolster the Cash account and $440,000 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	$	100,000	$	230,000
Marketable securities		0		26,000
Accounts receivable, net		581,000		380,000
Inventory		1,025,000		675,000
Prepaid expenses		26,000		30,000
Total current assets		1,732,000		1,341,000
Plant and equipment, net		1,759,600		1,450,000
Total assets	$	3,491,600	$	2,791,000
Liabilities and Stockholders Equity
Liabilities:
Current liabilities	$	840,000	$	510,000
Bonds payable, 12%		650,000		650,000
Total liabilities		1,490,000		1,160,000
Stockholders' equity:
Common stock, $20 par		770,000		770,000
Retained earnings		1,231,600		861,000
Total stockholders’ equity		2,001,600		1,631,000
Total liabilities and stockholders' equity	$	3,491,600	$	2,791,000

Sabin Electronics
Comparative Income Statement and Reconciliation
	This Year		Last Year
Sales	$	5,400,000	$	4,590,000
Cost of goods sold		3,955,000		3,530,000
Gross margin		1,445,000		1,060,000
Selling and administrative expenses		669,000		564,000
Net operating income		776,000		496,000
Interest expense		78,000		78,000
Net income before taxes		698,000		418,000
Income taxes (30%)		209,400		125,400
Net income		488,600		292,600
Common dividends		118,000		97,000
Net income retained		370,600		195,600
Beginning retained earnings		861,000		665,400
Ending retained earnings	$	1,231,600	$	861,000

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 2/10, 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 $51 per share.

c. The dividend payout ratio.

d. The price-earnings ratio. (Assume that the industry norm for the price-earnings ratio is 8)

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 $2,540,000.)

d. The return on equity. (Stockholders’ equity at the beginning of last year was $1,621,000.)

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

Answer 1

earnings per share	net income / no.of shares outstanding
	this year ($)	last year ($)
net income	488600	292600
no.of shares outstanding	38500	38500
earnings per share	12.69	7.60
dividend yield ratio	dividend per share / price per share
	this year ($)	last year ($)
dividend	118000	97000
no.of shares outstanding	38500	38500
dividend per share	3.06	2.52
selling price per share	55	51
dividend yield ratio	5.57%	4.94%
dividend payout ratio	dividend per share / earnings per share
	this year ($)	last year ($)
dividend per share	3.06	2.52
earnings per share	12.69	7.6
dividend payout ratio	24.11%	33.16%
price-earnings ratio	market value per share / earnings per share
	this year ($)	last year ($)
market value per share	55	51
earnings per share	12.69	7.6
price-earnings ratio	4.33	6.71
book value per share of common stock	(stockholders equity-preferred equity) / no.of common shares
	this year ($)	last year ($)
stockholders equity	2001600	1631000
no.of shares outstanding	38500	38500
book value per share of common stock	51.99	42.36
gross margin percentage	(gross profit / sales)*100
	this year ($)	last year ($)
gross profit	1445000	1060000
sales	5400000	4590000
gross margin percentage	26.76%	23.09%
net profit margin percentage	(net profit / sales)*100
	this year ($)	last year ($)
net income	488600	292600
sales	5400000	4590000
net profit margin percentage	9.05%	6.37%
return on total assets	EBIT / average total assets
	this year ($)	last year ($)
EBIT	776000	496000
opening total assets	2791000	2540000
closing total assets	3491600	2791000
average total assets	3141300	2665500
return on total assets	24.70%	18.61%
return on equity	net income / average shareholders equity
	this year ($)	last year ($)
net income	488600	292600
opening shareholders equity	1631000	1621000
closing shareholders equity	2001600	1631000
average shareholders equity	1816300	1626000
return on equity	26.90%	18.00%
financial leverage	average total assets / average equity
	this year ($)	last year ($)
average total assets	3141300	2665500
average shareholders equity	1816300	1626000
financial leverage	1.73	1.64