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 $600,000 long-term loan from Gulfport State Bank, $150.000 of which will be used to bolster the cash account and $450,000 of which w be used to modernize equipment. The company's financial statements for the two most recent years follow. Last Year Sabin Electronics Comparative Balance Sheet This Year Assets Current assets: Cash $ 110,00 Marketable securities Accounts receivable, net 607,000 Inventory 1,045,000 Prepaid expenses 32.ee Total current assets 1,792,800 Plant and equipment, net 1,946,400 Total assets $3,738,400 Liabilities and Stockholders Equity Liabilities: Current liabilities $ 850,000 Bonds payable, 12% 750.00 Total liabilities 1,600,000 Stockholders' equity: Common stock, $20 par 790,000 Retained earnings 1,348,400 Total stockholders' equity 2, 138,400 Total liabilities and $3,738, 400 stockholders' equity $ 250,000 28,00 400.ee 695,000 32,000 1,405,000 1,470,000 $2,875,000 $ 400,000 750.000 1,150,000 790,000 935,000 1,725,000 $2,875,000 Sabin Electronics Comparative Income Statement and Reconciliation This Year Last Year Sales $5,500,000 $4.650.000 Cost of goods sold 3,975,000 3,550,000 Gross margin 1,525,000 1,100,000 Selling and administrative 673,000 568,000 expenses Net operating income 852,00 532,000 Interest expense 99.990 90,000 Net income before taxes 762,000 442,000 Income taxes (384) 228,600 132,600 Net income 533,400 309,400 Common dividends 120,000 99,000 Net income retained 413,400 210,400 Beginning retained earnings — 724,600 Ending retained earnings $1,348,400 $ 935,000 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,n30. 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 $50 per share. 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 $2,670,000.) d. The return on equity. (Stockholders' equity at the beginning of last year was $1715,000.) e. Is the company's financial leverage positive or negative?

Answer 1

Requirement 1: Compute the ratios as follows

	Particulars	Current Year	Last Year
a.	Net income available for common shares	$533,400	$309,400
	÷ Average number of common shares ($790,000 ÷ $20 per share)	39,500	39,500
	Earnings per share	$13.50	$7.83
b.	Common dividend paid	$120,000	$99,000
	÷ Number of common shares ($790,000 ÷ $20 per share)	$39,500	$39,500
	Common dividend per share	$3.04	$2.51
	÷ Market price share	$60	$50
	Dividend yield ratio	5.1%	5.0%
c.	Common dividend per share	$3.04	$2.51
	÷ Earnings per share	$13.50	$7.83
	Dividend payout ratio	22.5%	32.0%
d.	Market price per share	$60	$50
	÷ Earnings per share	$13.50	$7.83
	Price-earnings ratio	4.44	6.38
e.	Common shareholders 'equity	$2,138,400	$1,725,000
	÷ Number of common shares	39,500	39,500
	Book value per share	$54.14	$43.67

Requirement 2: Compute the following ratios

	Particulars	Current Year	Last Year
a.	Gross margin	$1,525,000	$1,100,000
	÷ Sales revenue	$5,500,000	$4,650,000
	Gross margin percentage	27.7%	23.7%
b.	Net income	$533,400	$309,400
	÷ Sales revenue	$5,500,000	$4,650,000
	Net profit margin percentage	9.7%	6.7%
c.	Net income	$533,400	$309,400
	Add: Interest paid (after tax) ($90,000 × (1−30%))	$63,000	$63,000
	Total	$596,400	$372,400
	÷ Average total assets (($3,738,400 + $2,875,000) ÷ 2)	$3,306,700	$2,772,500
	Return on total assets	18.0%	13.4%
d.	Net income	$533,400	$309,400
	÷ Average stockholders' equity (($2,138,400 + $1,725,000) ÷ 2)	$1,931,700	$1,720,000
	Return on equity	27.6%	18.0%

e. The financial leverage is positive in the current year as well as previous year because the current year and previous year return on equity is higher when compared to return on total assets.