Question

Assume that you are considering purchasing stock as an investment. You have narrowed the choice to...

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

.

Homework Answers

Answer #1

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:

  • Verge's quick ratio is slightly higher than that of Express. It means, Verge is more liquid than Express.
  • Verge's inventory turnover ratio is higher than that of Express, it means Verge's inventory is fast moving than Express' inventory.
  • Verge's debt ratio is lower than that of Express, lower debt ratio is good for the companies. Verge is better in this case.
  • Return on common stock holder's equity is higher in Verge as compare to Express, it means Verge company's shareholders get more return on the equity invested rather than Express.
  • I will invest into Verge on the basis of above analysis.
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