L. Konrath Company is considering extending credit to D. Hawk Company. L. Konrath Company estimated that sales to D. Hawk Company would amount to $2 million each year. L. Konrath Company, a wholesaler, sells throughout the Midwest. D. Hawk Company, a retail chain operation, has a number of stores in the Midwest. L. Konrath Company has had a gross profit of approximately 60% in recent years and expects to have a similar gross profit on the D. Hawk Company order. The D. Hawk Company order is approximately 15% of L. Konrath Company's present sales. Data from recent statements of D. Hawk Company follow:
|
(In millions)
|
2007
|
2008
|
2009
|
|
Assets
|
|
|
|
|
Current assets:
|
|
|
|
|
Cash
|
$2.60
|
$1.80
|
$1.60
|
|
Government securities (cost)
|
0.4
|
0.2
|
-
|
|
Accounts and notes receivable (net)
|
8
|
8.5
|
8.5
|
|
Inventories
|
2.8
|
3.2
|
2.8
|
|
Prepaid assets
|
0.7
|
0.6
|
0.6
|
|
Total current assets
|
14.5
|
14.3
|
13.5
|
|
Property, plant, and equipment (net)
|
4.3
|
5.4
|
5.9
|
|
Total assets
|
$18.80
|
$19.70
|
$19.40
|
|
Liabilities and Equities
|
|
|
|
|
Current liabilities
|
$6.90
|
$8.50
|
$9.30
|
|
Long-term debt, 6%
|
3
|
2
|
1
|
|
Total liabilities
|
9.9
|
10.5
|
10.3
|
|
Shareholders' equity
|
8.9
|
9.2
|
9.1
|
|
Total liabilities and equities
|
$18.80
|
$19.70
|
$19.40
|
|
Income
|
|
|
|
|
Net sales
|
$24.20
|
$24.50
|
$24.90
|
|
Cost of goods sold
|
16.9
|
17.2
|
18
|
|
Gross margin
|
7.3
|
7.3
|
6.9
|
|
Selling and administrative expenses
|
6.6
|
6.8
|
7.3
|
|
Earnings (loss) before taxes
|
0.7
|
0.5
|
0.4
|
|
Income taxes
|
0.3
|
0.2
|
0.2
|
|
Net income
|
$0.40
|
$0.30
|
($0.20)
|
Required
a. Calculate the following for D. Hawk Company for 2009:
1. Rate of return on total assets
2. Acid-test ratio
3. Return on sales
4. Current ratio
5. Inventory turnover
b. As part of the analysis to determine whether L. Konrath Company should extend credit to D. Hawk Company, assume the ratios were calculated from D. Hawk Company statements. For each ratio, indicate whether it is a favorable, an unfavorable, or a neutral statistic in the decision to grant D. Hawk Company credit. Briefly explain your choice in each case.
|
Ratio
|
2007
|
2008
|
2009
|
|
Rate of return on total assets
|
1.96%
|
1.12%
|
0.87%
|
|
Return on sales
|
1.69%
|
0.99%
|
0.69%
|
|
Acid-test ratio
|
1.73
|
1.36
|
1.19
|
|
Current ratio
|
2.39
|
1.92
|
1.67
|
|
Inventory turnover (times per year)
|
4.41
|
4.32
|
4.52
|
|
Equity relationships:
|
|
|
|
|
Current liabilities
|
36.00%
|
43.00%
|
48.00%
|
|
Long-term liabilities
|
16
|
10.5
|
5
|
|
Shareholders' equity
|
48
|
46.5
|
47
|
| |
100.00%
|
100.00%
|
100.00%
|
|
Asset relationships:
|
|
|
|
|
Current assets
|
77.00%
|
72.50%
|
69.50%
|
|
Property, plant, and equipment
|
23
|
27.5
|
30.5
|
| |
100.00%
|
100.00%
|
100.00%
|
c. Would you grant credit to D. Hawk Company? Support your answer with facts given in the problem.
d. What additional information, if any, would you want before making a final decision?