Chapter 4, Problem 18P

Use the following information for P4—17 and P4—18:

The Hershey Company is one of the world’s leading producers of chocolates, candies, and confections. It sells chocolates and candies, mints and gums, baking ingredients, toppings, and beverages. Hershey’s consolidated balance sheets for 20X2 and 20X3 follow.

Ratios Analysis: Hershey Refer to the information for Hershey On the preceding page. Additional information for 20X3 is as follows (amounts in millions):

Required:

Next Level Compute the following ratios for 20X3. Provide a brief description of what each ratio reveals about Hershey.

1. 1. return on common equity
2. 2. debt-to-assets
3. 3. debt-to-equity
4. 4. current
5. 5. quick (Hershey uses cash and equivalents, short terms securities, and receivables in their quick ratio calculation.)
6. 6. inventory turnover days
7. 7. accounts receivable turnover days
8. 8. accounts payable turnover days
9. 9. operating cycle (in days)
10. 10. total asset turnover

To determine

Determine the return on common equity ratio of Company H for 20X3.

Explanation of Solution

Determine the return on common equity ratio of Company H for 20X3:

Step 1: Calculate the average total common stockholders’ equity.

$\begin{array}{c}\begin{array}{l}\text{Average total common}\\ \text{stockholders’ equity}\end{array}\}\text{=}\left\{\frac{\left[\begin{array}{l}\text{Total common stocholders' equity, ending+}\\ \text{Total common stocholders' equity, beginning+}\end{array}\right]}{2}\right\}\\ =\left\{\frac{\left[\begin{array}{l}\$1,616.1\text{million}\\ +\$1,048.4\text{million}\end{array}\right]}{2}\right\}\\ =\frac{\$2,664.5}{2}\\ =\$1,332.25\text{ million}\end{array}$

Step 2: Calculate the return on common equity ratio of C&C Incorporation for 20X3.

$\begin{array}{c}\text{Return on common equity = }\frac{\text{Net income}}{\text{Average total common stocholders' equity}}\\ =\frac{\$820.5\text{million}}{\$1,332.25\text{ million}}\\ =0.616\end{array}$

Hence, the return on common equity ratio of Company H for 20X3 is 0.616.

Comment:

Return on common equity ratio indicates that Company H generated a 61.6% return for its common shareholders.

To determine

Determine the debt-to-assets ratio of Company H for 20X3.

Explanation of Solution

Determine the debt-to-assets ratio of Company H for 20X3:

$\begin{array}{c}\text{Debt-to-assets ratio = }\frac{\text{Total liabilities}}{\text{Total assets}}\\ =\frac{\$3,741.4\text{million}}{\text{\$5,357}\text{.5}\text{million}}\\ =0.698\end{array}$

Hence, the debt-to-assets ratio of Company H for 20X3 is 0.698.

Comment:

Debt-to-assets ratio indicates that Company H’s 69.8% of total assets are financed by its creditors.

To determine

Determine the debt-to-equity ratio of Company H for 20X3.

Explanation of Solution

Determine the debt-to-equity ratio of Company H for 20X3:

$\begin{array}{c}\text{Debt-to-equity ratio = }\frac{\text{Total liabilities}}{\text{Total common stocholders' equity}}\\ =\frac{\$3,741.4\text{million}}{\text{\$1,616}\text{.1}\text{million}}\\ =2.32\end{array}$

Hence, the debt-to- equity ratio of Company H for 20X3 is 2.32.

Comment:

Debt-to-assets ratio indicates that Company H has $2.32 in total liabilities for every of $1.00 in equity.

To determine

Determine the current ratio of Company H for 20X3.

Explanation of Solution

Determine the current ratio of Company H for 20X3:

$\begin{array}{c}\text{Current ratio = }\frac{\text{Current assets}}{\text{Current liabilities}}\\ =\frac{\$2,487.3\text{million}}{\text{\$1,408}\text{.0 million}}\\ =1.77\end{array}$

Hence, the current ratio of Company H for 20X3 is 1.77.

Comment:

Current ratio indicates that Company H has $1.77 in current assets for every of $1.00 in current liabilities.

To determine

Determine the quick ratio of Company H for 20X3.

Explanation of Solution

Determine the quick ratio of Company H for 20X3:

$\begin{array}{c}\text{Quick ratio = }\frac{\text{Quick assets}}{\text{Current liabilities}}\\ =\frac{\left[\text{Cash and cash equivalents +Recceivables}\right]}{\text{Current liabilities}}\\ =\frac{\left[\$1,118.5\text{million}+\$477.9\text{million}\right]}{\text{\$1,408}\text{.0million}}\\ =1.13\end{array}$

Hence, the quick ratio of Company H for 20X3 is 1.13.

Comment:

Quick ratio indicates that Company H has $1.13 in quick assets (cash and receivables) for every of $1.00 in current liabilities.

To determine

Determine the inventory turnover in days of Company H for 20X3.

Explanation of Solution

Determine the inventory turnover in days of Company H for 20X3:

Step 1: Calculate the average inventory.

$\begin{array}{c}\text{Average inventory=}\left(\frac{\text{Ending inventory +Beinning inventory}}{2}\right)\\ =\left(\frac{\text{\$659}\text{.5million + \$633}\text{.3million}}{2}\right)\\ =\left(\frac{\$1,292.8}{2}\right)\\ =\$646.4\text{ million}\end{array}$

Step 2: Calculate the inventory turnover.

$\begin{array}{c}\text{Inventory turnover= }\left[\frac{\text{Cost of goods sold}}{\text{Average inventory}}\right]\\ =\frac{\text{\$3,865}\text{.2}\text{million}}{\$646.4\text{ million}}\\ =5.979\text{ times}\end{array}$

Step 3: Calculate the inventory turnover in days of C&C Incorporation for 20X3.

$\begin{array}{c}\text{Inventory turnover days = }\frac{\text{365 days}}{\text{Inventory turnover}}\\ =\frac{365}{5.979\text{ times}}\\ =61\text{days}\end{array}$

Hence, the inventory turnover days of Company H for 20X3 are 61 days.

Comment:

On an average Company H takes 61 days to convert inventory into sales in the operation cycle.

To determine

Determine the accounts receivable turnover in days of Company H for 20X3.

Explanation of Solution

Determine the accounts receivable turnover in days of Company H for 20X3:

Step 1: Calculate the average accounts receivable.

$\begin{array}{c}\text{Average accounts receivable =}\left(\frac{\begin{array}{l}\text{Ending accounts receivable }\\ \text{+Beinning accounts receivable}\end{array}}{2}\right)\\ =\left(\frac{\$477.9\text{million +\$461}\text{.4million}}{2}\right)\\ =\left(\frac{\$939.3}{2}\right)\\ =\$469.65\text{million}\end{array}$

Step 2: Calculate the accounts receivable turnover.

$\begin{array}{c}\text{Accounts receivable turnover= }\frac{\text{Total credit sales}}{\text{Average accounts receivable}}\\ =\frac{\text{\$7,146}\text{.1}\text{million}}{\$469.65\text{ million}}\\ =15.21\text{ times}\end{array}$

Step 3: Calculate the accounts receivable turnover in days of C&C Incorporation for 20X3.

$\begin{array}{c}\text{Accounts receivable turnover days = }\frac{\text{365 days}}{\text{Accounts receivable turnover}}\\ =\frac{\text{365 days}}{15.21\text{ times}}\\ =24\text{days}\end{array}$

Hence, the accounts receivable turnover days of Company H for 20X3 are 24 days.

Comment:

On an average Company H takes 24 days to collect its receivables from its customers.

To determine

Determine the accounts payable turnover in days of Company H for 20X3.

Explanation of Solution

Determine the accounts payable turnover in days of Company H for 20X3.

Step 1: Determine the amount of inventory purchases.

$\begin{array}{c}\text{Inventory purchases = Cost of goods sold + Change in inventory}\\ \text{=Cost of goods sold +}\left(\text{Ending inventory}-\text{Beginning inventory}\right)\\ =\$3,865.2\text{million +}\left(\$659.5\text{million}-\$633.3\text{million}\right)\\ =\$3,891.4\text{million}\end{array}$

Step 2: Calculate the average accounts payable.

$\begin{array}{c}\text{Average accounts payable =}\left(\frac{\begin{array}{l}\text{Ending accounts receivable }\\ \text{+Beinning accounts receivable}\end{array}}{2}\right)\\ =\left(\frac{\$461.5\text{million +\$442}\text{.0million}}{2}\right)\\ =\frac{\$903.5}{2}\\ =\$451.75\text{ million}\end{array}$

Step 3: Calculate the accounts payable turnover.

$\begin{array}{c}\text{Accounts payable turnover = }\left[\frac{\text{Inventory purchases}}{\text{Average accounts receivable}}\right]\\ =\left[\frac{\text{\$3,891}\text{.4}\text{million}}{\$451.75\text{ million}}\right]\\ =8.61\text{times}\end{array}$

Step 4: Determine the accounts payable turnover in days.

$\begin{array}{c}\text{Accounts payable turnover days = }\frac{\text{365 days}}{\text{Accounts payable turnover }}\\ =\frac{\text{365 days}}{8.61\text{ times}}\\ =42\text{days}\end{array}$

Hence, the accounts payable turnover in days of Company H for 20X3 is 42 days.

Comment:

On an average Company H takes 42 days to pay its payables to its suppliers.

To determine

Determine the operating cycle in days of Company H for 20X3.

Explanation of Solution

Determine the operating cycle in days of Company H for 20X3:

$\begin{array}{c}\text{Operating cycle}\left(\text{in days}\right)\text{ =}\left[\begin{array}{l}\text{Inventory turnover days+}\\ \text{Accounts receivable turnover days}-\\ \text{Accounts payables turnover days}\end{array}\right]\\ =61\text{days +24days}-42\text{days}\\ \text{=43days}\end{array}$

Hence, the operating cycle in days of Company H for 20X3 is 43 days.

Comment:

Company H takes 43days to complete an operating cycle (the purchase of inventory and collection of cash from accounts receivable).

To determine

Determine the total assets turnover ratio of Company H for 20X3.

Explanation of Solution

Determine the total assets turnover ratio of Company H for 20X3:

Step 1: Calculate average total assets.

$\begin{array}{c}\text{Average total assets =}\left[\frac{\left(\begin{array}{l}\text{Beginning total assets }\\ \text{+Ending total assets}\end{array}\right)}{2}\right]\\ =\left[\frac{\left(\begin{array}{l}\text{\$5,357}\text{.5million }\\ \text{+\$4,754}\text{.8million}\end{array}\right)}{2}\right]\\ =\left(\frac{\$10,112.3}{2}\right)\\ =\$5,056.15\text{ million}\end{array}$

Step 2: Calculate the total assets turnover ratio of C&C Incorporation for 20X3.

$\begin{array}{c}\text{Total assets turnover ratio = }\frac{\text{Total revenues}}{\text{Average total assets}}\\ =\frac{\text{\$7,146}\text{.1million}}{\$5,056.15\text{ million}}\\ =1.41\end{array}$

Hence, the total assets turnover ratio of Company H for 20X3 is 1.41.

Comment:

Total assets turnover ratio indicates that Company H has generated $1.41 in sales for every of $1.00 in assets