Question

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 Assets Current assets: Cash $ 1,000,000 $ 1,240,000 Marketable securities 0 300,000 Accounts receivable, net 2,860,000 1,960,000 Inventory 3,640,000 2,400,000 Prepaid expenses 270,000 210,000 Total current assets 7,770,000 6,110,000 Plant and equipment, net 9,600,000 9,090,000 Total assets $17,370,000 $15,200,000 Liabilities and Stockholders' Equity Liabilities: Current liabilities $ 4,050,000 $ 3,060,000 Note payable, 10% 3,700,000 3,100,000 Total liabilities 7,750,000 6,160,000 Stockholders' equity: Common stock, $75 par value 7,500,000 7,500,000 Retained earnings 2,120,000 1,540,000 Total stockholders' equity 9,620,000 9,040,000 Total liabilities and $17,370,000 $15,200,000 stockholders' equity Lydex Company Comparative Income Statement and Reconciliation This Year Last Year Sales (all on account) $15, 900,000 $13,980,000 Cost of goods sold 12,720,000 10,485,000 Gross margin 3,180,000 3,495,000 Selling and administrative expenses 1,410,000 1,620,000 Net operating income 1,770,000 1,875,000 Interest expense 370,000 310,000 Net income before taxes 1,400,000 1,565,000 Income taxes (30%) 420,000 469,500 Net income 980,000 1,095,500 Common dividends 400,000 547,750 Net income retained 580,000 547,750 Beginning retained 1,540,000 992,250 earnings Ending retained earnings $ 2,120,000 $ 1,540,000

To begin your assignment you gather the following financial data and ratios that are typical of companies in Lydex Company’s industry:

Problem 14-15 Part 1

Required:

1. You decide first to assess the company’s performance in terms of debt management and profitability. Compute the following for both this year and last year: (Round your "Percentage" answers to 1 decimal place and other answers to 2 decimal places.)

a. The times interest earned ratio.

b. The debt-to-equity ratio.

c. The gross margin percentage.

d. The return on total assets. (Total assets at the beginning of last year were $13,110,000.)

e. The return on equity. (Stockholders’ equity at the beginning of last year totaled $8,492,250. There has been no change in common stock over the last two years.)

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

Answer 1

	This Year	Last Year
Times Interest earned ratio =Net Operating Income / Interest expenses
Times Interest earned ratio for This Year =$1,770,000 / $370,000	4.78
Times Interest earned ratio for Last Year =$1,875,000 / $310,000		6.05
Debt to Equity ratio =Total Liabilities / Total shareholder's equity
Debt to Equity ratio for This Year =$7,750,000 / $9,620,000	0.81
Debt to Equity ratio for Last Year =$6,160,000 / $9,040,000		0.68
Gross Margin Percentage =Gross Margin / Sales
Gross Margin Percentage for This Year =($3,180,000 / $15,900,000)*100	20.0%
Gross Margin Percentage for Last Year =($3,495,000 / $13,980,000)*100		25.0%
Return on Total Assets =Net Income / Average Total Assets
Return on Total Assets for This Year =[$980,000 / ($15,200,000+$17,370,000)/2]	6.0%
Return on Total Assets for Last Year =[$1,095,500 / ($13,110,000+$15,200,000)/2]		7.7%
Return on equity =Net income / Average Stockholder's equity
Return on equity for This Year =[$980,000 / ($9,040,000+$9,620,000)/2]	10.5%
Return on equity for Last Year =[$1,095,500 / ($8,492,250+$9,040,000)/2]		12.5%