Chapter 3, Problem 1CC

a)

Summary Introduction

Case synopsis:

Company S is an aircraft company, which was formed, by Person M and Person T before 10 years. This company manufactures and sells airplanes. However, the company has received fair reviews on its products for reliability and safety. It can complete its manufacturing process within 5 weeks.

Person C was hired recently by the Company S to assess and evaluate the financial performance of the company. He has mastered Finance and so he has been recruited in the company’s finance department. Person M and T has given him the financial statement of Company S. Person C has collected the ratios of industry of light airplane manufacturing.

Characters in the case:

• Company S
• Person C
• Person M
• Person T

Adequate information:

• Company S has niche market in which it sells initially to people who own and fly their own airplanes
• Company S takes up a different method for its operations

To calculate: The ratios listed in the light-plane industries ratio using Company S financial statement

Explanation of Solution

Given information: The income statement of Company S as on 2014 provides the following information.

• The sales is $24,092,400
• The cost of the goods sold is $17,982,000
• The earnings before interest and tax is $2,445,600
• The net income is $1,206,720

The balance sheet of the Company as on 2014 provides the following information:

• The total current asset is $3,765,864
• The current assets is $438,048
• The total assets is $18,544,680
• The total current liabilities is $2,594,496
• The long term debt is $4,590,000
• The total equity is $11,360,184
• The total liabilities and equity is $18,544,680

Formula to calculate the current ratio:

$\text{Current ratio}=\frac{\text{Current assets}}{\text{Current liabilities}}$

Compute the current ratio:

$\begin{array}{c}\text{Current ratio}=\frac{\text{Current assets}}{\text{Current liabilities}}\\ \text{Current ratio }=\frac{\$3,765,864}{\$2,594,496}\\ =1.451\text{ times}\end{array}$

Hence, the current ratio is 1.451 times.

b)

Summary Introduction

To calculate: The ratios listed in the light-plane industries ratio using Company S financial statement

Explanation of Solution

Formula to calculate the quick ratio:

$\text{Quickratio}=\frac{\left(\text{Current assets}-\text{Inventory}\right)}{\text{Current liabilities}}$

Compute the quick ratio:

$\begin{array}{c}\text{Quick ratio}=\frac{\left(\text{Current assets}-\text{Inventory}\right)}{\text{Current liabilities}}\\ =\frac{\left(\$3,765,864-\$1,486,200\right)}{\$2,594,496}\\ =0.8786\text{ times}\end{array}$

Hence, the quick ratio is 0.8786 times.

c)

Summary Introduction

To calculate: The ratios listed in the light-plane industries ratio using Company S financial statement

Explanation of Solution

Formula to calculate the cash ratio:

$\text{Cash ratio}=\frac{\text{Cash}}{\text{Current liabilities}}$

Compute the cash ratio:

$\begin{array}{c}\text{Cash ratio}=\frac{\text{Cash}}{\text{Current liabilities}}\\ =\frac{\$438,048}{\$2,594,496}\\ =0.1688\text{ times}\end{array}$

Hence, the cash ratio is 0.1688 times.

d)

Summary Introduction

To calculate: The ratios listed in the light-plane industries ratio using Company S financial statement

Explanation of Solution

Formula to calculate the total asset turnover ratio:

$\text{Total asset turnover ratio}=\frac{\text{Sales}}{\text{Total assets}}$

Compute the total asset turnover ratio:

$\begin{array}{c}\text{Total asset turnover ratio}=\frac{\text{Sales}}{\text{Total assets}}\\ =\frac{\$24,092,400}{\$18,544,680}\\ =1.299\text{ times}\end{array}$

Hence, the total asset turnover ratio is 1.299 times.

e)

Summary Introduction

To calculate: The ratios listed in the light-plane industries ratio using Company S financial statement

Explanation of Solution

Formula to calculate the inventory turnover ratio:

$\text{Inventory turnover ratio}=\frac{\text{Cost of goods sold}}{\text{Inventory}}$

Compute the inventory turnover ratio:

$\begin{array}{c}\text{Inventory turnover ratio}=\frac{\text{Cost of goods sold}}{\text{Inventory}}\\ =\frac{\$17,982,000}{\$1,486,200}\\ =12.099\text{ times}\end{array}$

Hence, the inventory turnover ratio is 12.099 times.

f)

Summary Introduction

To calculate: The ratios listed in the light-plane industries ratio using Company S financial statement

Explanation of Solution

Formula to calculate the receivables turnover ratio:

$\text{Receivables turnover ratio}=\frac{\text{Sales}}{\text{Accounts receivables}}$

Compute the receivables turnover ratio:

$\begin{array}{c}\text{Receivables turnover ratio}=\frac{\text{Sales}}{\text{Accounts receivables}}\\ =\frac{\$24,092,400}{\$1,841,616}\\ =13.082\text{ times}\end{array}$

Hence, the receivables turnover ratio is 13.082 times.

g)

Summary Introduction

To calculate: The ratios listed in the light-plane industries ratio using Company S financial statement

Explanation of Solution

Formula to calculate the total debt ratio:

$\text{Total debt ratio = }\frac{\left(\text{Total assets}-\text{Total equity}\right)}{\text{Total assets}}$

Compute the total debt ratio:

$\begin{array}{c}\text{Total debt ratio = }\frac{\left(\text{Total assets}-\text{Total equity}\right)}{\text{Total assets}}\\ =\frac{\left(\$18,544,680-\$11,360,184\right)}{\$18,544,680}\\ =\frac{7,184,496}{\$18,544,680}\\ =0.387\text{ times}\end{array}$

Hence, the total debt ratio is 0.387 times.

h)

Summary Introduction

To calculate: The ratios listed in the light-plane industries ratio using Company S financial statement

Explanation of Solution

Formula to calculate the debt-equity ratio:

$\text{Debt-equity ratio}=\frac{\text{Total debt}}{\text{Total equity}}$

Compute the debt-equity:

$\begin{array}{c}\text{Debt-equity ratio}=\frac{\text{Total debt}}{\text{Total equity}}\\ =\frac{\$2,594,496+\$4,590,000}{\$11,360,184}\\ =\$0.632\text{ times}\end{array}$

Hence, the debt-equity ratio is 0.632 times.

Note: The total debt is calculated by adding the total-long term debt and total current liabilities.

i)

Summary Introduction

To calculate: The ratios listed in the light-plane industries ratio using Company S financial statement

Explanation of Solution

Formula to calculate the equity multiplier:

$\text{Equity multiplier ratio}=1+\text{debt-equity ratio}$

Compute the equity multiplier ratio:

$\begin{array}{c}\text{Equity multiplier ratio}=1+\text{debt-equity ratio}\\ =1+0.632\\ =1.632\text{ times}\end{array}$

Hence, the equity multiplier ratio is 1.632 times.

j)

Summary Introduction

To calculate: The ratios listed in the light-plane industries ratio using Company S financial statement

Explanation of Solution

Formula to calculate the times interest earned ratio:

$\text{Times interest earned}=\frac{\text{Earnings before interest and taxes}}{\text{Interest}}$

Compute the times interest earned ratio:

$\begin{array}{c}\text{Times interest earned}=\frac{\text{Earnings before interest and taxes}}{\text{Interest}}\\ =\frac{\$2,445,600}{\$434,400}\\ =5.629\text{ times}\end{array}$

Hence, the times interest earned are 5.629 times.

k)

Summary Introduction

To calculate: The ratios listed in the light-plane industries ratio using Company S financial statement

Explanation of Solution

Formula to calculate the cash coverage ratio:

$\text{Cash coverage ratio}=\frac{\text{Earnings before interest and taxes}+\text{Depreciation}}{\text{Interest}}$

Compute the cash coverage ratio:

$\begin{array}{c}\text{Cash coverage ratio}=\frac{\text{Earnings before interest and taxes}+\text{Depreciation}}{\text{Interest}}\\ =\frac{\$2,445,600+\$786,000}{\$434,400}\\ =7.43\text{ times}\end{array}$

Hence, the cash coverage ratio is 7.43 times.

l)

Summary Introduction

To calculate: The ratios listed in the light-plane industries ratio using Company S financial statement

Explanation of Solution

Formula to calculate the profit margin ratio:

$\text{Profit margin}=\frac{\text{Net income}}{\text{Sales}}$

Compute the profit margin:

$\begin{array}{c}\text{Profit margin}=\frac{\text{Net income}}{\text{Sales}}\\ =\frac{\$1,206,720}{\$24,092,400}\\ =0.0501\text{ or 5}\text{.01}\%\end{array}$

Hence, the profit margin is 5.01%.

m)

Summary Introduction

To calculate: The ratios listed in the light-plane industries ratio using Company S financial statement

Explanation of Solution

Formula to calculate the return on assets (ROA):

$\text{ROA}=\frac{\text{Net income}}{\text{Total assets}}$

Compute the return on assets (ROA):

$\begin{array}{c}\text{ROA}=\frac{\text{Net income}}{\text{Total assets}}\\ =\frac{\$1,206,720}{\$18,544,680}\\ =0.0650\text{ or 6}.50\%\end{array}$

Hence, the return on assets is 0.0650 or 6.50%

n)

Summary Introduction

To calculate: The ratios listed in the light-plane industries ratio using Company S financial statement

Explanation of Solution

Formula to calculate the return on equity (ROE):

$\text{ROA}=\frac{\text{Net income}}{\text{Total equity}}$

Compute the return on equity (ROE):

$\begin{array}{c}\text{ROE}=\frac{\text{Net income}}{\text{Total equity}}\\ =\frac{\$246,000}{\$11,360,184}\\ =0.0216\text{ or 2}\text{.16}\%\end{array}$

Hence, the return on equity is 0.0216 or 2.16%.