Question

You have just been hired as a financial analyst for Lydex Company, a manufacturer of safety helmets. Your boss has asked you to perform a comprehensive analysis of the company’s financial statements, including comparing Lydex’s performance to its major competitors. The company’s financial statements for the last two years are as follows:

Lydex Company Comparative Balance Sheet
	This Year		Last Year
Assets
Current assets:
Cash	$	960,000	$	1,260,000
Marketable securities		0		300,000
Accounts receivable, net		2,700,000		1,800,000
Inventory		3,900,000		2,400,000
Prepaid expenses		240,000		180,000
Total current assets		7,800,000		5,940,000
Plant and equipment, net		9,300,000		8,940,000
Total assets	$	17,100,000	$	14,880,000
Liabilities and Stockholders' Equity
Liabilities:
Current liabilities	$	3,900,000	$	2,760,000
Note payable, 10%		3,600,000		3,000,000
Total liabilities		7,500,000		5,760,000
Stockholders' equity:
Common stock, $78 par value		7,800,000		7,800,000
Retained earnings		1,800,000		1,320,000
Total stockholders' equity		9,600,000		9,120,000
Total liabilities and stockholders' equity	$	17,100,000	$	14,880,000

Lydex Company Comparative Income Statement and Reconciliation
	This Year		Last Year
Sales (all on account)	$	15,750,000	$	12,480,000
Cost of goods sold		12,600,000		9,900,000
Gross margin		3,150,000		2,580,000
Selling and administrative expenses		1,590,000		1,560,000
Net operating income		1,560,000		1,020,000
Interest expense		360,000		300,000
Net income before taxes		1,200,000		720,000
Income taxes (30%)		360,000		216,000
Net income		840,000		504,000
Common dividends		360,000		252,000
Net income retained		480,000		252,000
Beginning retained earnings		1,320,000		1,068,000
Ending retained earnings	$	1,800,000	$	1,320,000

To begin your assignment you gather the following financial data and ratios that are typical of companies in Lydex Company’s industry:

Current ratio	2.3
Acid-test ratio	1.2
Average collection period	30	days
Average sale period	60	days
Return on assets	9.5	%
Debt-to-equity ratio	0.65
Times interest earned ratio	5.7
Price-earnings ratio	10

Required:

1. You decide first to assess the company’s performance in terms of debt management and profitability. Compute the following for both this year and last year: (Round your "Percentage" answers to 1 decimal place and other answers to 2 decimal places.)

a. The times interest earned ratio.

b. The debt-to-equity ratio.

c. The gross margin percentage.

d. The return on total assets. (Total assets at the beginning of last year were $12,960,000.)

e. The return on equity. (Stockholders’ equity at the beginning of last year totaled $9,048,000. There has been no change in common stock over the last two years.)

f. Is the company’s financial leverage positive or negative?

Answer 1

Solution:

Ratios:

a)	Times Interest Earned Ratio	This Year	Last Year
	Earnings Before Interest and Taxes (Net Operating Income)	1560000	1020000
	Interest Expense	360000	300000
	Times Interest Earned Ratio (Earnings Before Interest and Taxes / Interest Expense)	4.33	3.40
b)	Debt to Equity Ratio
	Total Debt (Total Liabilities)	$7,500,000	$5,760,000
	Stockholder's Equity	$9,600,000	$9,120,000
	Debt to Equity Ratio (Total Debt / Total Stockholder's Equity)	0.78	0.63
c)	Gross Margin Percentage
	Gross Profit	$3,150,000	$2,580,000
	Sales Revenue	$15,750,000	$12,480,000
	Gross Margin Percentage (Gross Profit / Sales x 100)	20.00%	20.67%
d)	Return on Total Assets
	Operating Income	$1,560,000	$1,020,000
	Average Total Assets
	Beginning Assets	$14,880,000	$12,960,000
	Ending Assets	$17,100,000	$14,880,000
	Average Total Assets (Beginning + Ending)/2	$15,990,000	$13,920,000
	Return on Total Assets (Operating Income / Avg Total Assets x 100)	9.76%	7.33%
e)	Return on Equity
	Net Income after tax	$840,000	$504,000
	Average Stockholder’s Equity
	Beginning	$9,120,000	$9,048,000
	Ending	$9,600,000	$9,120,000
	Average Stockholder’s Equity (Beg + Ending) / 2	$9,360,000	$9,084,000
	Return on Equity (Net Income / Avg Stockholder's Equity x 100)	8.97%	5.55%

f) The company’s financial leverage is positive

Hope the above calculations, working and explanations are clear to you and help you in understanding the concept of question.... please rate my answer...in case any doubt, post a comment and I will try to resolve the doubt ASAP…thank you