PROBLEM 1 - Ratios; Consider Advisability of Incurring Long-Term Debt
At the end of the year, the following information was obtained from the accounting records of Harrison Electronics, Inc.
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Sales (all on credit)
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$2,750,000
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Cost of goods sold
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1,781,000
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Average inventory
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375,000
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Average accounts receivable
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282,000
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Interest expense
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45,000
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Income tax expense
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84,000
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Net income
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159,000
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Average investment in assets
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1,800,000
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Average stockholders' equity
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895000
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Instructions -
a. From the information given, compute the following.
1. Inventory turnover.
2. Accounts receivable turnover.
3. Total operating expenses.
4. Gross profit percentage.
5. Return on average stockholders' equity.
6. Return on average assets.
b. Harrison Electronics has an opportunity to obtain a long-term loan at an annual interest rate of 10 percent and could use this additional capital at the same rate of profitability as indicated by the given data. Would obtaining the loan be desirable from the viewpoint of the stockholders? Explain.
PROBLEM 2 - Home Depot, Inc.
ANALYSIS OF THE FINANCIAL STATEMENTS OF A PUBLICLY OWNED CORPORATION
This Comprehensive Problem is to acquaint you with the content of the 2015 financial statements of Home Depot, Inc., reproduced in Appendix A of this textbook. (The 2015 financial statements are for the fiscal year ended January 31, 2016.) The problem contains three major parts, which are independent of one another: Part I is designed to familiarize you with the general contents of a company's financial statements; Part II involves analysis of the company's liquidity: and Part III analyzes the trend in its profitability.
If you work this problem as a group assignment, each group member should be prepared to discuss the group's findings and conclusions in class.
A good starting point for understanding the financial statements of a company such as Home Depot, Inc., is to understand the accounting policies used in preparing those statements. The first note accompanying the financial statements provides a brief description of the major accounting policies the company used. Most of the areas discussed in this note have been covered in this text.
Part I - Annual reports include not only comparative financial statements but also other sources of information, such as:
- A multiyear summary of financial highlights, a summary of key statistics for the past 5 or 10 years.
- Several pages of Notes that accompany the financial statements.
- Reports by management and by the independent auditors in which they express their respective responsibilities for the financial statements.
Instructions
Answer each of the following questions and explain where in the statements, notes, or other sections of the annual report you located the information used in your answer.
a. How many years are covered in each of the primary comparative financial statements? Were all of these statements audited? Name the auditors. What were the auditors' conclusions concerning these statements?
b. Home Depot, Inc., combines its statement of retained earnings with another financial statement. Where are details about changes in the amount of retained earnings found?
c. Over the three years presented, have the company's annual net cash flows been positive or negative from (1) operating activities, (2) investing-activities, and (3) financing activities? Has the company's cash balance increased or decreased during each of these three years?
Part II - Assume that you are the credit manager of a medium-size supplier of building materials and related products. Home Depot wants to make credit purchases from your company, with payment due in 60 days.
Instructions
a. As general background, read the first note to the financial statements, "Summary of Significant Accounting Policies." Next, compute the following for the fiscal years ending January 31, 2016, and February 1, 2015 (round percentages to the nearest tenth of 1 percent, and other computations to one decimal place).
1. Current ratio.
2. Quick ratio.
3. Amount of working capital.
4. Percentage change in working capital from the prior year.
5. Percentage change in cash and cash equivalents from the prior year.
b. On the basis of your analysis in part a, does the company's liquidity appear to have increased or decreased during the most recent fiscal year? Explain.
c. Other than the ability of Home Depot to pay for its purchases, do you see any _major considerations that should enter into your company's decision? Explain.
d. Your company assigns each customer one of the four credit ratings listed below. Assign a credit rating to Home Depot, Inc., and write a memorandum explaining your decision. (In your memorandum, you may refer to any of your computations or observations in parts a through c, and to any information contained in the annual report.)
POSSIBLE CREDIT RATINGS
A. Outstanding Little or no risk of inability to pay. For customers in this category, we fill any reasonable order without imposing a credit limit. The customer's credit is reevaluated annually.
B. Good Customer has good debt-paying ability but is assigned a credit limit that is reviewed every 90 days. Orders above the credit limit are accepted only on a cash basis.
C. Marginal Customer appears sound, but credit should be extended only on a 30-day basis and with a relatively low credit limit. Creditworthiness and credit limit are reevaluated every 90 days.
D. Unacceptable Customer does not qualify for credit.
Part III - As general background, study the "Five-Year Summary of Financial and Operating Results."
Instructions
a. Compute the following for the fiscal years ending January 31, 2016, and February 1, 2015 (round percentages to the nearest tenth of 1 percent):
1. Percentage change in net sales (relative to the prior year).
2. Percentage change in net earnings.
3. Gross profit rate.
4. Net income as a percentage of sales.
5. Return on average total assets.
6. Return on average total equity.
b. Write a statement that describes your conclusion(s) concerning trends in Home Depot's profitability during the period covered in your analysis in part a above. Justify your conclusion(s).