Assume that you are considering purchasing stock as an investment. You have narrowed the choice to either Verge Corporation stock or Express Company stock and have assembled the following data for the two companies.Your strategy is to invest in companies that have low price-earnings ratios but appear to be in good shape financially. Assume that you have analyzed all other factors and that your decision depends on the results of ratio analysis.
Selected income statement data for the current year:
|
Verge |
Express |
|
|
Net sales (all on credit). . . . . . . . . . . . . . . . |
$599,000 |
$527,000 |
|
Cost of goods sold. . . . . . . . . . . . . . . . . . . . |
458,000 |
382,000 |
|
Income from operations. . . . . . . . . . . . . . . |
91,000 |
69,000 |
|
Interest expense. . . . . . . . . . . . . . . . . . . . . |
— |
10,000 |
|
Net income. . . . . . . . . . . . . . . . . . . . . . . . . . |
70,000 |
34,000 |
Selected balance sheet and market price data at end of current year:
|
Verge |
Express |
|
|
Current assets: |
||
|
Cash. . . . . . . . . . . . . . . . . . . . . . . |
$28,000 |
$38,000 |
|
Short-term investments. . . . . . . . . . |
7,000 |
13,000 |
|
Current receivables, net. . . . . . . . . . . |
189,000 |
168,000 |
|
Inventories. . . . . . . . . . . . . . . . . . . . . . |
219,000 |
190,000 |
|
Prepaid expenses. . . . . . . . . . . . . . . . |
18,000 |
12,000 |
|
Total current assets. . . . . . . . . . . . . . . |
461,000 |
421,000 |
|
Total assets. . . . . . . . . . . . . . . . . . . . . . . . . . . |
975,000 |
936,000 |
|
Total current liabilities. . . . . . . . . . . . . . . . . |
364,000 |
340,000 |
|
Total liabilities. . . . . . . . . . . . . . . . . . . . . . . . . |
666,000 |
693,000 |
|
Preferred stock, 9%, $150 par. . . . . . . . . . . . |
30,000 |
|
|
Common stock, $1 par (115,000 shares). . . . |
115,000 |
|
|
$5 par (10,000 shares) |
50,000 |
|
|
Total stockholders' equity. . . . . . . . . . . . . . . . |
309,000 |
243,000 |
|
Market price per share of common stock. . . . |
$7.32 |
$65.73 |
Selected balance sheet data at beginning of current year:
|
Verge |
Express |
|
|
Balance sheet: |
||
|
Current receivables, net. . . . . . . . . . . . . . . . . |
$146,000 |
$192,000 |
|
Inventories. . . . . . . . . . . . . . . . . . . . . . . . . . . . |
205,000 |
193,000 |
|
Total assets. . . . . . . . . . . . . . . . . . . . . . . . . . . |
852,000 |
914,000 |
|
Long-term debt. . . . . . . . . . . . . . . . . . . . . . . . |
— |
311,000 |
|
Preferred stock, 9%, $150 par. . . . . . . . . . . . |
30,000 |
|
|
Common stock, $1 par (115,000 shares). . . . |
115,000 |
|
|
$5 par (10,000 shares) |
50,000 |
|
|
Total stockholders' equity. . . . . . . . . . . . . . . . |
265,000 |
219,000 |
|
1. |
Compute the following ratios for both companies for the current year, and decide which company's stock better fits your investment strategy. |
|
|
a. |
Quick (acid-test) ratio |
|
|
b. |
Inventory turnover |
|
|
c. |
Days' sales in average receivables |
|
|
d. |
Debt ratio |
|
|
e. |
Times-interest-earned ratio |
|
|
f. |
Return on common stockholders' equity |
|
|
g. |
Earnings per share of common stock |
|
|
h. |
Price-earnings ratio |
|
Requirement 1. Compute the ratios for both companies for the
current year and decide which company's stock better fits your
investment strategy.
Begin by computing the ratios, starting with the quick
(acid-test) ratio. (Abbreviations used: Avg. = average, Cash* =
cash and cash equivalents, Mkt = market, o/s = outstanding, SE
= stockholders' equity, and ST = short-term.)
a. Quick (acid-test) ratio
Select the formula and then enter the amounts to calculate the
quick (acid-test) ratios. (Round the ratios to two decimal
places, X.XX.)
(
+
+
) /
=
Quick ratio
Verge
(
+
+
) /
=
Express
(
+
+
) /
=
b. Inventory turnover
Select the formula and then enter the amounts to calculate the
inventory turnover for each company. (Round the ratios to two
decimal places, X.XX.)
/
=
Inventory turnover
Verge
/
=
Express
/
=
c. Days' sales in average receivables
Select the formula and then enter the amounts to calculate days'
sales in average receivables for each company. (Use a 365-day
year. Round intermediary calculations to the nearest whole number,
X. Round your final answers to one decimal place, X.X.)
/
=
Days' sales in average receivables
Verge
/
=
Express
/
=
d. Debt ratio
Select the formula and then enter the amounts to calculate the debt
ratio for each company. (Enter the debt ratio in decimal form to
two decimal places, X.XX.)
/
=
Debt ratio
Verge
/
=
Express
/
=
e. Times-interest-earned ratio
Select the formula and then enter the amounts to calculate the
times-interest-earned ratio for Express. (Round the ratio to one
decimal place, X.X.)
/
=
Times-interest-earned ratio
Express
/
=
f. Return on common stockholders' equity
Select the formula and then enter the amounts to calculate the
return on common stockholders' equity (ROE) for each company.
(Complete all answer boxes. If an account has a zero balance,
enter a "0". Enter the ROE as a percentage rounded to the nearest
one-tenth percent, X.X%.)
(
-
) /
=
ROE
Verge
(
-
) /
=
%
Express
(
-
) /
=
%
g. Earnings per share of common stock
Select the formula and then enter the amounts to calculate earnings
per share (EPS) for each company. (Complete all answer boxes. If
an account has a zero balance, enter a "0". Round EPS to two
decimal places, X.XX.)
(
-
) /
=
EPS
Verge
(
-
) /
=
Express
(
-
) /
=
h. Price-earnings ratio
Select the formula and then enter the amounts to calculate the
price-earnings (P/E) ratio for each company. (Enter amounts in the
formula to two decimal places, X.XX, but then round the P/E
ratios to one decimal place, X.X, as needed.)
/
=
P/E ratio
Verge
/
=
Express
/
=
Which company's stock better fits your investment strategy?
The common stock of
▼
Express Company
Verge Corporation
seems to fit the investment strategy better. Its price-earnings ratio is
▼
higher than that of Express Company
higher than that of Verge Corporation
lower than that of Express Company
lower than that of Verge Corporation
,
and
▼
Express Company appears to be in slightly better shape than Verge Corporation
Verge Corporation appears to be in slightly better shape than Express Company
.
Calculating ratios for the company "Verge"
Answer(a): Quick ratio = Liquid Assets / Current liabilities
Liquid assets (in this question) = Cash, short term investments, current receivables, inventory
Quick ratio: 443000 / 364000 = 1.217
Answer(b): Inventory turnover ratio = Cost of goods sold / Average inventory
Average inventory = (ending inventory+beginning inventory) / 2
Average inventory: (219000+205000) / 2 = 212000
Inventory turnover ratio: 458000/212000 = 2.16 times
Answer(d): Debt Ratio = Total liabilities / Total assets
Debt Ratio: 666000 / 975000 = .68
Answer(e): Times interest earned ratio = EBIT or Income from operations / Interest expenses
In this case, Interest is not given so Times interest earned ratio cannot be calculated.
Answer(f): Return on common stockholder's equity = Net Income/ Shareholder's euity * 100
Return on common stockholder's equity: (70000 / 309000)*100 = 22.65%
Calculating ratios for the company "Express":
Answer(a): Quick ratio = Liquid Assets / Current liabilities
Liquid assets (in this question) = Cash, short term investments, current receivables, inventory
Quick ratio: 409000/340000 = 1.20
Answer(b): Inventory turnover ratio = Cost of goods sold / Average inventory
Average inventory = (ending inventory+beginning inventory) / 2
Average inventory: (190000+193000)/2 = 191500
Inventory turnover ratio: 382000/191500 = 1.99 times
Answer(d): Debt Ratio = Total liabilities / Total assets
Debt Ratio: 693000/936000 = .74
Answer(e): Times interest earned ratio = EBIT or Income from operations / Interest expenses
Times interest earned ratio: 69000/10000 = 6.9 times
Answer(f): Return on common stockholder's equity = Net Income/ Shareholder's euity * 100
Return on common stockholder's equity: (34000/243000)*100 = 13.99%
Analysis- Comparisng company Verge with company Express:
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