Chapter 17, Problem 5BPSB

To determine

Concept Introduction:

Current Ratio: Current Ratio is measure of the company’s ability to pay off its current liabilities using its current assets. It is calculated by dividing the total current assets by total current liabilities. The formula of the current ratio is as follows:

$CurrentRatio=\frac{Currentassets}{Currentliabilities}$

Acid test ratio: Acid test ration is also called Quick ratio. This ratio is calculated by dividing the quick assets (Cash, Cash equivalents, Short term investments and current receivables) by total current liabilities for the year. The formula for Acid test ratio is as follows:

$Acidtestratio=\frac{\left(Cash+Cashequivalents+Shortterminvestments+Accountsreceivables\right)}{CurrentLiabilities}$

Accounts receivable turnover ratio: This is an efficiency ratio that indicates the conversion of accounts receivable into cash. This ratio is calculated by dividing the Net credit Sales by the Average accounts receivable. The formula to calculate this ratio is as follows:

$Accountsreceivableturnoverratio=\frac{NetcreditSales}{Averageaccountsreceivable}$

Days Sales in receivable ratio: This is an efficiency ratio that indicates the period for which credit sales remain as receivable. The ratio is calculated by dividing 365 days by the Accounts receivable turnover ratio. The formula to calculate this ratio is as follows:

$DaysSalesinreceivableratio=\frac{365}{Accountsreceivableturnoverratio}$

Inventory Turnover Ratio: Inventory Turnover Ratio measures the efficiency of the company in converting its inventory into sales. It is calculated by dividing the Cost of goods sold by Average inventory. The formula of the Inventory Turnover Ratio is as follows:

$InventoryTurnoverRatio=\frac{Costofgoodssold}{Averageinventory}$

Note: Average inventory is calculated with the help of following formula:

$Averageinventory=\frac{(Beginninginventory+Endinginventory)}{2}$

Day’s sales in inventory: Days sales in inventory represent the number of days the inventory waits for the sale. It is calculated by dividing the 365 days by Inventory Turnover Ratio. The formula of the Days sales in inventory is as follows:

$Dayssalesininventory=\frac{365}{InventoryTurnoverRatio}$

Profit Margin Ratio:

Profit Margin Ratio is a profitability ratio that represents the percentage income earned on the sales. It is calculated by dividing the Net Income by the Sales. The formulas to calculate the Profit margin is as follows:

$ProfitMargin=\frac{NetIncome}{Sales}$

Asset Turnover Ratio:

Asset Turnover Ratio is an efficiency ratio that represents the sales earned on the average assets invested in the business. It is calculated by dividing the Sales by Average total assets. The formulas to calculate the Asset Turnover Ratio is as follows:

$AssetTurnoverRatio=\frac{Sales}{Averagetotalassets}$

Return on total Assets: The Return on total assets is profitability ratio that measures the percentage of profit earned on average assets invested in the business. Return on asset is calculated by dividing the net income by average total assets. The formula to calculate Return on assets is as follows:

$Returnonassets=\frac{Netincome}{AverageTotalAssets}$

Note: Average total assets are calculated as an average of beginning and ending total assets. The formula to calculate the average total assets is as follows:

$AveragetotalAssets=\frac{\left(Beginningtotalassets+Endingtotalassets\right)}{2}$

Return on Common Stockholder’s Equity:

Return on Equity is the rate of return earned by the Stockholders on their investment in the company. It is calculated with the help of following formula:

$\mathrm{Re}turnonEquity=\frac{NetIncome}{AverageStockholder’sEquity}$

The Average stock holder’s equity calculated with the help of following formula:

$Averagestockholder’sequity=\frac{(Beginningstockholder’sequity+Endingstockholder’sequity)}{2}$

Price Earnings Ratio:

The price earnings ratio shows the relationship between price of the share and earnings per share. It is calculated with the help of following formula:

$\text{Price Earnings Ratio=}\frac{\text{Market price per share}}{\text{Earnings per share}}$

Dividend Yield Ratio:

Dividend Yield ratio is calculated as percentage by dividing the Dividend per share by Market price per share. The formula for the Dividend Yield ratio is as follow:

$DividendYieldRatio=\frac{Dividendpershare}{Marketpricepershare}$

Requirement-1:

To determine: Current ratio, acid test ratio, accounts receivable turnover, inventory turnover, and day’s sales in inventory and, days sales uncollected for both the companies.

Answer to Problem 5BPSB

Solution: Current ratio, acid test ratio, accounts receivable turnover, inventory turnover, and day’s sales in inventory and, days sales uncollected for both the companies are as follows:

	Fargo Company	Ball Company
(a) Current Ratio	2.3	2.1
(b) Acid test Ratio	1.2	1.2
(c) Accounts Receivable Turnover	4.9	8.7
(d) Inventory Turnover	3.0	5.9
(e) Days Sales in inventory	120.5	61.8
(f) Days Sales Uncollected	71.6	41.8

Ball Company has better credit position.

Explanation of Solution

Explanation: Current ratio, acid test ratio, accounts receivable turnover, inventory turnover, and day’s sales in inventory and, days sales uncollected for both the companies are calculated as follows:

(a) Current Ratio:	Fargo Company	Ball Company
Cash	$ 20,000	$ 36,500
Accounts Receivable, net	$ 77,100	$ 70,500
Current notes receivable	$ 11,600	$ 9,000
Merchandise Inventory	$ 86,800	$ 82,000
Prepaid Expense	$ 9,700	$ 10,100
Total Current Assets (A)	$ 205,200	$ 208,100
Total Current Liabilities (B)	$ 90,500	$ 97,000
(a) Current Ratio = A/B =	2.3	2.1
(b) Acid test Ratio:	Fargo Company	Ball Company
Cash	$ 20,000	$ 36,500
Accounts Receivable, net	$ 77,100	$ 70,500
Current notes receivable	$ 11,600	$ 9,000
Total Quick Assets (A)	$ 108,700	$ 116,000
Total Current Liabilities (B)	$ 90,500	$ 97,000
(b) Acid test Ratio = A/B =	1.2	1.2
(c) Accounts Receivable Turnover:	Fargo Company	Ball Company
Sales (A)	$ 393,600	$ 667,500
Beginning Accounts Receivable, net (Including notes) (B)	$ 72,200	$ 73,300
Ending Accounts Receivable, net (Including notes) (C)	$ 88,700	$ 79,500
Average Accounts Receivables (D) = (B+C)/2	$ 80,450	$ 76,400
(c) Accounts Receivable Turnover = A/D =	4.9	8.7
(d) Inventory Turnover:	Fargo Company	Ball Company
Cost of Goods sold (A)	$ 290,600	$ 480,000
Beginning Inventory (B)	$ 105,100	$ 80,500
Ending Inventory (C)	$ 86,800	$ 82,000
Average Inventory (D) = (B+C)/2	$ 95,950	$ 81,250
(d) Inventory Turnover= A/D=	3.0	5.9
(e) Days Sales in inventory:	Fargo Company	Ball Company
(d) Inventory Turnover:	3.0	5.9
(e) Days Sales in inventory = 365/d	120.5	61.8
(f) Days Sales Uncollected:	Fargo Company	Ball Company
(c) Accounts Receivable Turnover	4.9	8.7
(f) Days Sales Uncollected= 365/c	74.6	41.8

Conclusion

Conclusion: Hence, Ball Company has better credit position.

To determine

Requirement-2:

To determine: Profit margin ratio, total asset turnover ratio, return on total asset, return on common stock holder’s equity, price earnings ratio and, dividend yield for both the companies.

Answer to Problem 5BPSB

Solution: Profit margin ratio, total asset turnover ratio, return on total asset, return on common stock holder’s equity, price earnings ratio and, dividend yield for both the companies are as follows:

	Fargo Company	Ball Company
(a) Profit Margin Ratio	8.6%	9.2%
(b) Total Asset turnover	1.03	1.48
(c) Return on total assets	8.8%	13.7%
(d) Return on Common Stockholder's Equity	17.8%	23.7%
(e) Price earnings ratio	19.7	11.4
(f) Dividend Yield	6.0%	6.0%

Ball company stock should be recommended as a better investment option, because it is more profitable than Farrgo company stock.

Explanation of Solution

Explanation: Profit margin ratio, total asset turnover ratio, return on total asset, return on common stock holder’s equity, price earnings ratio and, dividend yield for both the companies are calculated as follows:

(a) Profit Margin Ratio:	Fargo Company	Ball Company
Net Income (A)	$ 33,850	$ 61,700
Sales (B)	$ 393,600	$ 667,500
(a) Profit Margin Ratio =A/B =	8.6%	9.2%
(b) Total Asset turnover:	Fargo Company	Ball Company
Sales (A)	$ 393,600	$ 667,500
Beginning Total assets (B)	$ 383,400	$ 443,000
Ending Total assets (C)	$ 382,100	$ 460,400
Average Total assets (D) = (B+C)/2	$ 382,750	$ 451,700
(b) Total Asset turnover = A/D =	1.03	1.48
(c) Return on total assets:	Fargo Company	Ball Company
Net Income (A)	$ 33,850	$ 61,700
Beginning Total assets (B)	$ 383,400	$ 443,000
Ending Total assets (C)	$ 382,100	$ 460,400
Average Total assets (D) = (B+C)/2	$ 382,750	$ 451,700
(c) Return on total assets =A/D=	8.8%	13.7%
(d) Return on Common Stockholder's Equity:	Fargo Company	Ball Company
Net Income (A)	$ 33,850	$ 61,700
Beginning Stockholder's Equity (B)	$ 182,100	$ 250,700
	(133000+49100)	(141000+109700)
Ending Stockholder's Equity(C)	$ 198,600	$ 270,100
	(133000+65600)	(141000+129100)
Average Stockholder's Equity (D) = (B+C)/2	$ 190,350	$ 260,400
(d) Return on Common Stockholder's Equity=A/D=	17.8%	23.7%
(e) Price earnings ratio:	Fargo Company	Ball Company
Basic Earnings per share (A)	$ 1.27	$ 2.19
Market Price per share (B)	$ 25	$ 25
(e) Price earnings ratio = B/A=	19.7	11.4
(f) Dividend Yield:	Fargo Company	Ball Company
Cash Dividend Per share (A)	$ 1.50	$ 1.50
Market Price per share (B)	$ 25	$ 25
(f) Dividend Yield= A/B=	6.0%	6.0%

Conclusion

Conclusion: Ball company stock should be recommended as a better investment option, because it is more profitable than Farrgo company stock.