Chapter 13, Problem 9P

1)

To determine

Compute the given ratios for Year 3 of Incorporation CPK.

Answer to Problem 9P

Compute the given ratios for Year 3 of Incorporation CPK.

Ratio	Formula	Calculation	Result
Return on Equity (ROE)	$\frac{\text{Net}\text{Income}}{\text{Average}\text{Total}\text{Stockholder'}\text{Equity}}$	$\frac{\text{\$(406)}}{\left(\$194,411+\$189,250\right)}$	(2.12)%
Net profit margin	$\frac{\text{Net}\text{Income}}{\text{Net Sales Revenue}}$	$\frac{\text{\$(406)}}{\$642,231}$	(0.06)%
Inventory turnover	$\frac{\text{Cost of Goods Sold}}{\text{Average Inventory}}$	$\frac{\text{\$528,285}}{\left(\$5,827+\$5,557\right)÷2}$	92.81 times
Current ratio	$\frac{\text{Current}\text{Assets}}{\text{Current}\text{Liabilities}}$	$\frac{\$49,625}{\$93,151}$	0.53 times
Quick ratio	$\frac{\text{Quick}\text{Assets}}{\text{Current}\text{Liabilities}}$	$\frac{\$21,230+\$11,594}{\$93,151}$	0.35  times
Debt-to-equity ratio	$\frac{\text{Total}\text{Liabilities}}{\text{Total}\text{Stockholder's}\text{Equity}}$	$\frac{\$93,151+\$9,886+\$33,177+\$319}{\$194,411}$	7.02 times
Price/Earnings (P/E) ratio	$\frac{\text{Market Price per Share}}{\text{Earnings}\text{per Share}}$	$\frac{\$1.12}{\$0.02}$	(56.00)  times

Table (1)

Explanation of Solution

Return on equity ratio:

Rate of return on equity ratio is used to determine the relationship between the net income available for the common stockholders’ and the average common equity that is invested in the company.

$\text{Return on Equity}\text{=}\frac{\text{Net}\text{Income}}{\text{Average}\text{Total}\text{Stockholder'}\text{Equity}}$

Return on equity of the Incorporation CPK is (2.12) %.

Profit margin:

Profit margin ratio is used to determine the percentage of net income that is being generated per dollar of revenue or sales.

$\text{Net profit margin}\text{=}\frac{\text{Net}\text{Income}}{\text{Net Sales Revenue}}$

Net profit margin of the Incorporation CPK is (0.06) %.

Inventory turnover ratio: Inventory turnover ratio is used to determine the number of times inventory used or sold during the particular accounting period.

$\text{Inventory Turnover Ratio =}\frac{\text{Cost of Goods Sold }}{\text{Average Inventory}}$

Inventory turnover ratio of the Incorporation CPK is 92.81%.

Current ratio: Current ratio is used to determine the relationship between current assets and current liabilities. The ideal current ratio is 2:1.

$\text{Current ratio}\text{=}\frac{\text{Current}\text{Assets}}{\text{Current}\text{Liabilities}}$

Current ratio of the Incorporation CPK is 0.53 times.

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.

$\text{Quick Ratio}\text{=}\frac{\text{Quick}\text{Assets}}{\text{Current}\text{Liabilities}}$

Quick ratio of the Incorporation CPK is 0.35 times.

Debt-equity ratio: The debt-to-equity ratio indicates that the company’s debt as a proportion of its stockholders’ equity.

$\text{Debt-equity ratio}\text{=}\frac{\text{Total}\text{Liabilities}}{\text{Total}\text{Stockholder's}\text{Equity}}$

Debt-to-Equity ratio of the Incorporation CPK is 7.02 times.

Price/Earnings Ratio: It depicts the relation of market price of a share to earnings per share of that company. The price/earnings ratio presents the market value of the amount invested to earn $1 by a company. It is major tool to be used by investors before the decisions related to investments in a company.

$\text{Price/Earnings Ratio}\text{=}\frac{\text{Market Price per Share }}{\text{Earnings per Share}}$

Price/Earnings ratio of the Incorporation CPK is (56.00) times.

2)

To determine

Identify that Whether the calculated inventory turnover for Incorporation CPK reasonable or not.

Explanation of Solution

Incorporation CPK is engaging the restaurant business. Inventory turnover ratio of the Incorporation CPK is 92.81 which is very high. It is due to the nature of the business that is Incorporation CPK is in a business where purchasing inventory, processing and selling food to customers is on daily basis.

Hence, the inventory turnover ratio of the Incorporation CPK is reasonable.