
a.
Compute the ratios for Company W for the years 2013 and 2012
a.

Answer to Problem 6AP
Company W | ||
Computation of Ratio | ||
Particulars |
Amount $ (in 000’s) |
Amount $ (in 000’s) |
2013 | 2012 | |
Cash and cash equivalents | $18,000 | $12,000 |
Accounts receivable | 55,000 | 43,000 |
Inventory | 120,000 | 105,000 |
Prepaid expenses | 20,000 | 14,000 |
Total Current Assets (A) | 213,000 | 174,000 |
Total Current Liabilities (B) | 90,000 | 82,000 |
Current Ratio | 2.37 | 2.12 |
Quick Ratio: | ||
Cash and Cash Equivalents | $18,000 | $12,000 |
Trade Receivables | 55,000 | 43,000 |
Total Quick Assets (A) | 73,000 | 55,000 |
Total Current Liabilities (B) | 90,000 | 82,000 |
Quick ratio | 0.81 | 0.67 |
Operating-cash-flows-to-current-liabilities: | ||
Beginning Current liabilities (A) | 82,000 | 78,000 |
Ending Current Liabilities (B) | 90,000 | 82,000 |
Average Current Liabilities (C) | 86,000 | 80,000 |
65,200 | 60,500 | |
Operating-cash-flows-to-current-liabilities | 0.76 | 0.76 |
Inventory Turnover Ratio: | ||
Cost of Goods Sold (A) | 541,200 | 433,920 |
Beginning Inventory (B) | 105,000 | 87,000 |
Ending Inventory (C) | 120,000 | 105,000 |
Average Inventory (D) | 112,500 | 96,000 |
Inventory Turnover Ratio | 4.81 Times | 4.52 Times |
Debt-to-Equity: | ||
Total Current Liabilities | 90,000 | 82,000 |
Bonds payable | 225,000 | 160,000 |
Total Liabilities (A) | 315,000 | 242,000 |
Preferred stock | 75,000 | 75,000 |
Common stock | 200,000 | 200,000 |
Retained earnings | 94,000 | 68,000 |
Total Stockholders’ Equity (B) | 369,000 | 343,000 |
Debt-to-Equity | 0.85 | 0.70 |
Times-Interest-Earned: | ||
Income before interest and income tax expense (A) | 107,400 | 94,880 |
Interest Expense (B) | 22,500 | 16,000 |
Times-Interest-Earned | 4.77 | 5.93 |
Return on Assets: | ||
Beginning Total Assets (A) | 585,000 | 493,000 |
Ending Total Assets (B) | 684,000 | 585,000 |
Average Total Assets (C) | 634,500 | 539,000 |
Net Income (D) | 62,000 | 57,580 |
Return on Assets | 9.77% | 10.68% |
Return on Common Stockholders’ Equity: | ||
Net Income | 62,000 | 57,580 |
Less: Preferred Dividends | (6,750) | (6,750) |
Net Income Available for Common Stockholders (A) | 55,250 | 50,830 |
Common stock | 200,000 | 200,000 |
Retained earnings | 94,000 | 68,000 |
Ending Stockholders’ Equity (B) | 294,000 | 268,000 |
Beginning Common Stockholders’ Equity (C) | 268,000 | 236,000 |
Average Common Stockholders’ Equity (D) | 281,000 | 252,000 |
Return on Common Stockholders’ Equity | 19.67% | 20.17% |
Table (1)
Explanation of Solution
Current ratio: Current ratio is one of the
Quick ratio: It is a ratio used to determine a company’s ability to pay back its current liabilities by liquid assets that are current assets except inventory and prepaid expenses.
Operating-cash-flow-to-current-liabilities ratio: The operating-cash-flow-to-current-liabilities ratio measures the firm’s ability to pay the current liabilities from the cash flows from operating activities. It can be calculated by using the given formula:
Inventory Turnover Ratio: This ratio is a financial metric used by a company to quantify the number of times inventory is used or sold during the accounting period. It is calculated by using the formula:
Debt–to-equity ratio: The debt-to-equity ratio indicates that the company’s debt as a proportion of its
Number of times interest was earned: Number of times interest is earned quantifies the number of times the earnings before interest and taxes can pay the interest expense. First, determine the sum of income before income tax and interest expense. Then, divide the sum by interest expense.
Return on assets: Return on assets is the financial ratio which determines the amount of net income earned by the business with the use of total assets owned by it. It indicates the magnitude of the company’s earnings with relative to its total assets. Return on investment is calculated as follows:
Return on common stockholders’ equity ratio: It is a profitability ratio that measures the profit generating ability of the company from the invested money of the shareholders. The formula to calculate the return on equity is as follows:
b.
Calculate common size percentage for each year’s income statement.
b.

Explanation of Solution
Common size financial statements: These are the financial statements in which all the items are expressed as percentages, assuming a base value, to help the intra-comparison of financial data for different years, and inter-comparison of data with other companies.
Formula:
Prepare a common size income statement of Company W for the years ended 2012 and 2013.
W Company | ||||
Common-Size Income Statement | ||||
For the years 2012 and 2013 | ||||
Particulars | 2013 | 2012 | ||
Amount $ | Percentage of Sales | Amount $ | Percentage of Sales | |
Sales | 820,000 | 100% | 678,000 | 100% |
Less: Cost of Goods Sold | 541,200 | 66% | 433,920 | 64% |
Gross Profit | 278,800 | 34% | 244,080 | 36% |
Less: Selling and Administrative Expenses | 171,400 | 21% | 149,200 | 22% |
Income before Interest Expense and Income Taxes | 107,400 | 13% | 94,880 | 14% |
Less: Interest Expenses | 22,500 | 3% | 16,000 | 2% |
Income before Income Taxes | 84,900 | 10% | 78,880 | 12% |
Less: Income Tax Expense | 22,900 | 3% | 21,300 | 3% |
Net Income | 62,000 | 8% | 57,580 | 8% |
Table (2)
c.
Comment on the results of the analysis.
c.

Explanation of Solution
Analysis of the ratios:
Company W | |||
Ratio Analysis | |||
Ratios | 2012 | 2013 | Change |
Current Ratio | 2.12 | 2.37 | Increased |
Quick Ratio | 0.67 | 0.81 | Increased |
Operating-cash-flows-to-current-liabilities | 0.76 | 0.76 | No Change |
Inventory Turnover Ratio | 4.52 Times | 4.81 Times | Increased |
Debt-to-Equity | 0.70 | 0.85 | Increased |
Times-Interest-Earned | 5.93 | 4.77 | Decreased |
Return on Assets | 10.68% | 9.77% | Decreased |
Return on Common Stockholders’ Equity | 20.17% | 19.67% | Decreased |
Table (3)
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