Chapter 9, Problem 13E

Ratio analysis

Compute the specified ratios using Duluth Company’s balance sheet for 2018:

The average number of common stock shares outstanding during 2018 was 880 shares. Net income for

the year was $40,000.

Required

Compute each of the following and round computations to two decimal points:

a. Current ratio.

b. Earnings per share.

c. Quick (acid-test) ratio.

d. Return on investment.

e. Return on equity.

f. Debt to equity ratio.

To determine

Compute the current ratio for Company D for 2018 from the data given in balance sheet.

Explanation of Solution

Current ratio: Current ratio is one of the liquidity ratios, which measures the capacity of the company to meet its short-term obligations using its current assets. Current ratio is calculated by using the formula:

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

Determine the current ratio of Company D:

$\begin{array}{c}\text{Current ratio}=\frac{\text{Current Assets}}{\text{Current Liabilities}}\\ =\frac{\$154,000}{\$30,000}\\ =5.13:1\end{array}$

Working Note:

Determine the current assets.

$\begin{array}{c}\text{Current assets}=\text{ Cash}+\left(\begin{array}{l}\text{Marketable }\\ \text{securities}\end{array}\right)+\left(\begin{array}{l}\text{Accounts }\\ \text{receivable}\end{array}\right)+\text{Inventory}\\ =\$36,000+\$24,000+\$50,000+\$44,000\\ =\$154,000\end{array}$

Determine the current liabilities.

$\begin{array}{c}\text{Current liabilities}=\text{ Accounts payable}+\text{Current notes payable}\\ =\$23,000+\$7,000\\ =\$30,000\end{array}$

Conclusion

Thus, the current ratio of Company D is 5.13:1.

To determine

Compute the earnings per share for Company D for 2018 from the data given in balance sheet.

Explanation of Solution

Earnings per Share: Earnings per share help to measure the profitability of a company. Earnings per share are the amount of profit that is allocated to each share of outstanding stock.

  $\text{Earnings per share}=\frac{\text{Net earnings available for common stock}}{\text{Average number of outstanding common shares}}$

Determine the earnings per share of Company D:

$\begin{array}{c}\text{Earnings per share}=\frac{\text{Net earnings available for common stock}}{\text{Average number of outstanding common shares}}\\ =\frac{\text{\$40,000}}{880\text{ shares}}\\ =\$45.45\text{ per share}\end{array}$

Conclusion

Thus, the earnings per share of Company D is $45.45 per share.

To determine

Compute the quick (acid-test) ratio for Company D for 2018 from the data given in balance sheet.

Explanation of Solution

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. Quick ratio is calculated as follows:

$\text{Quick}\left(\text{acid-test}\right)\text{ ratio}=\frac{\text{Quick assets}}{\text{Current liabilities}}$

Determine the quick ratio of Company D:

$\begin{array}{c}\text{Quick}\left(\text{acid-test}\right)\text{ ratio}=\frac{\text{Quick assets}}{\text{Current liabilities}}\\ =\frac{\text{\$110,000}}{\text{\$30,000}}\\ =3.67:1\end{array}$

Determine the quick assets.

$\begin{array}{c}\text{Quick assets}=\text{ Cash}+\left(\begin{array}{l}\text{Marketable }\\ \text{securities}\end{array}\right)+\left(\begin{array}{l}\text{Accounts }\\ \text{receivable}\end{array}\right)\\ =\$36,000+\$24,000+\$50,000\\ =\$110,000\end{array}$

Conclusion

Thus, the quick ratio of Company D is 3.67:1.

To determine

Compute the return on investment for Company D for 2018 from the data given in balance sheet.

Explanation of Solution

Return on investments (assets): Return on investments (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:

$\text{Return on investments}=\frac{\text{Net income }}{\text{Average total assets}}$

Determine the return on investment ratio of Company D:

$\begin{array}{c}\text{Return on investments}=\frac{\text{Net income }}{\text{Average total assets}}\\ =\frac{\$40,000}{\$400,000}\\ =10.00\%\end{array}$

Note: As there is no information given regarding Average total assets, the Total asset is assumed as Average total asset.

Conclusion

Thus, the return on investment of Company D is 10.00%.

To determine

Compute the return on equity for Company D for 2018 from the data given in balance sheet.

Explanation of Solution

Return on equity: It is one of the profitability ratios. Return on average equity ratio is used to determine the relationship between the net income available for the common stockholders’ and the average common stock. Return on average equity is calculated as follows:

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

Determine the return on equity ratio of Company D:

$\begin{array}{c}\text{Return on equity }\text{=}\frac{\text{Net}\text{Income}}{\text{Average}\text{Total}\text{Stockholders'}\text{Equity}}\\ =\frac{\text{\$40,000}}{\$319,000}\\ =12.54\%\end{array}$

Working Note:

Determine the amount of average total stockholders’ equity.

$\begin{array}{c}\text{Total stockholders' equity}=\text{ Common stock}+\text{Retained earnings}\\ =\$200,000+\$119,000\\ =\$319,000\end{array}$

Note: As there is no information given regarding Average total stockholders’ equity, the Total stockholders’ equity is assumed as Average total stockholders’ equity.

Conclusion

Thus, the return on equity of Company D is 12.54%.

To determine

Compute the debt to equity ratio for Company D for 2018 from the data given in balance sheet.

Explanation of Solution

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

  $\text{Debt-to-equity ratio}=\frac{\text{Total liabilities}}{\text{Total stockholders' equity}}$

Determine the debt-to-equity ratio of Company D:

$\begin{array}{c}\text{Debt-toequity ratio}=\frac{\text{Total liabilities}}{\text{Total stockholders' equity}}\\ =\frac{\$81,000}{\$319,000}\\ =25.39\%\end{array}$

Working Note:

Determine the amount of total stockholders’ equity.

$\begin{array}{c}\text{Total stockholders' equity}=\text{ Common stock}+\text{Retained earnings}\\ =\$200,000+\$119,000\\ =\$319,000\end{array}$

Determine the amount of total liabilities.

$\begin{array}{c}\text{Total liabilities}=\left(\begin{array}{l}\text{Accounts }\\ \text{payable}\end{array}\right)+\left(\begin{array}{l}\text{Current notes}\\ \text{ payable}\end{array}\right)+\left(\begin{array}{l}\text{Mortgage}\\ \text{ payable}\end{array}\right)+\left(\begin{array}{l}\text{Bonds }\\ \text{payable}\end{array}\right)\\ =\$23,000+\$7,000+\$8,000+\$43,000\\ =\$81,000\end{array}$

Conclusion

Thus, the debt-to-equity ratio of Company D is 25.39%.