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	$	980,000	$	1,220,000
Marketable securities		0		300,000
Accounts receivable, net		2,780,000		1,880,000
Inventory		3,620,000		2,200,000
Prepaid expenses		260,000		200,000
Total current assets		7,640,000		5,800,000
Plant and equipment, net		9,560,000		9,070,000
Total assets	$	17,200,000	$	14,870,000
Liabilities and Stockholders' Equity
Liabilities:
Current liabilities	$	4,030,000	$	3,020,000
Note payable, 10%		3,680,000		3,080,000
Total liabilities		7,710,000		6,100,000
Stockholders' equity:
Common stock, $75 par value		7,500,000		7,500,000
Retained earnings		1,990,000		1,270,000
Total stockholders' equity		9,490,000		8,770,000
Total liabilities and stockholders' equity	$	17,200,000	$	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:

Current ratio	2.4
Acid-test ratio	1.1
Average collection period	32	days
Average sale period	60	days
Return on assets	9.5	%
Debt-to-equity ratio	0.7
Times interest earned ratio	5.8
Price-earnings ratio	10

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 $13,090,000.)

e. The return on equity. (Stockholders’ equity at the beginning of last year totaled $8,236,250. There has been no change in common stock over the last two years.)

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

2. You decide next to assess the company’s stock market performance. Assume that Lydex’s stock price at the end of this year is $98 per share and that at the end of last year it was $66. For both this year and last year, compute: (Round your "Percentage" answers to 1 decimal place and other intermediate and final answers to 2 decimal places.)

a. The earnings per share.

b. The dividend yield ratio.

c. The dividend payout ratio.

d. The price-earnings ratio.

e. The book value per share of common stock.

3. You decide, finally, to assess the company’s liquidity and asset management. For both this year and last year, compute:

a. Working capital.

b. The current ratio. (Round your final answers to 2 decimal places.)

c. The acid-test ratio. (Round your final answers to 2 decimal places.)

d. The average collection period. (The accounts receivable at the beginning of last year totaled $1,690,000.) (Use 365 days in a year. Round your intermediate calculations and final answer to 2 decimal place.)

e. The average sale period. (The inventory at the beginning of last year totaled $2,050,000.) (Use 365 days in a year. Round your intermediate calculations and final answer to 2 decimal place.)

f. The operating cycle. (Round your intermediate calculations and final answer to 2 decimal place.)

g. The total asset turnover. (The total assets at the beginning of last year totaled $14,630,000.) (Round your final answers to 2 decimal places.)

Answer 1

1
a.	Times interest earned ratio=Earnings before interest and taxes (EBIT)/Interest expense
	Here, EBIT=Net operating income
					This Year	Last Year
	Net operating income				1968000	1833000
	Interest expense				368000	308000
	Times interest earned ratio				5.35	5.95
b.	Debt to equity ratio=Debt/Stockholder's equity
	Here, Debt=Note payable
					This Year	Last Year
	Note payable				3680000	3080000
	Total stockholder's equity				9490000	8770000
	Debt to equity ratio				0.39	0.35
c.	Gross margin percentage=Gross margin/Sales
					This Year	Last Year
	Gross margin				3176000	3445000
	Sales				15880000	13780000
	Gross margin percentage				20.00%	25.00%
d.	Return on total assets=EBIT/Avergae total assets
	Average total assets=(Beg. Bal of total assets+End. Bal of total assets)/2
	Here, EBIT=Net operating income
					This Year	Last Year
	EBIT				1968000	1833000
	Beg. Bal of total assets				14870000	13090000
	End. Bal of total assets				17200000	14870000
	Average Total assets				16035000	13980000
	Return on total assets				12.27%	13.11%
e.	Return on equity=Net income/Average stockholde's equity
	Average stockholder's equity=(Beg. Bal of stockholder's equity+End. Bal of stockholder's equity)/2
					This Year	Last Year
	Net income				1120000	1067500
	Beg. Bal of stockholder's equity				8770000	8236250
	End. Bal of stockholder's equity				9490000	8770000
	Average stockholder's equity				9130000	8503125
	Return on equity				12.27%	12.55%
f.	If return on equity > interest rate on debt, fainancial leverage is positive, otherwise negative
					This Year	Last Year
	Return on equity				12.27%	12.55%
	Interest on notes payable				10%	10%
	Since ROE>Interest on debt,
	Financial leverage is positive
2
a.	Earnings per share=Net income/Number of common shares
	Number of common shares=Common stock/Par value=7500000/75=100000 shares
					This Year	Last Year
	Net income				1120000	1067500
	Number of common shares				100000	100000
	Earnings per share				11.2	10.68
b.	Dividend yield ratio=Dividend per share/Price per share
	Dividend per share=Dividend/Number of common shares
					This Year	Last Year
	Common dividend				400000	533750
	Number of common shares				100000	100000
	Dividend per share				4	5.3375
	Price per share				98	66
	Dividend yield ratio				4.08%	8.09%
c.	Dividend payout ratio=Dividend per share/Earnings per share
					This Year	Last Year
	Dividend per share				4	5.3375
	Earnings per share				11.2	10.675
	Dividend payout ratio				35.71%	50.00%
d.	Price-earnings ratio=Price per share/Earnings per share
					This Year	Last Year
	Price per share				98	66
	Earnings per share				11.2	10.675
	Price-earning ratio				8.75	6.18