Case Scenario:
You have just been hired as a loan officer at Fairfield State Bank. Your supervisor has given you a file containing a request from Hedrick Company, a manufacturer of auto components, for a $1,000,000 five-year loan. Financial statement data on the company for the last two years are given below:
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Hedrick Company
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Comparative Balance Sheet
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This Year
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Last Year
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Assets
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|
|
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Current assets:
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|
|
|
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Cash
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$
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306,000
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$
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410,000
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Marketable securities
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0
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105,000
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Accounts receivable, net
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895,000
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602,000
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Inventory
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1,420,000
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850,000
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Prepaid expenses
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78,000
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64,000
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|
|
|
|
|
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Total current assets
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2,699,000
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2,031,000
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Plant and equipment, net
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3,321,700
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3,085,100
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|
|
|
|
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Total assets
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$
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6,020,700
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$
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5,116,100
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|
|
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Liabilities and Stockholders Equity
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Liabilities:
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Current liabilities
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$
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1,250,000
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$
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760,000
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Bonds payable, 10%
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1,220,000
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1,170,000
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|
|
|
|
|
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Total liabilities
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2,470,000
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1,930,000
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|
|
|
|
|
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Stockholders equity:
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|
|
|
|
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Preferred stock, 8%, $30 par value
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600,000
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600,000
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Common stock, $40 par value
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2,000,000
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2,000,000
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Retained earnings
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950,700
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586,100
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|
|
|
|
|
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Total stockholders equity
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3,550,700
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3,186,100
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|
|
|
|
|
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Total liabilities and stockholders equity
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$
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6,020,700
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$
|
5,116,100
|
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Hedrick Company
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Comparative Income Statement and Reconciliation
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This Year
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Last Year
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Sales (all on account)
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$
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5,420,000
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$
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4,330,000
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Cost of goods sold
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4,090,000
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3,250,000
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|
|
|
|
|
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Gross margin
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1,330,000
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1,080,000
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Selling and administrative expenses
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530,000
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510,000
|
|
|
|
|
|
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Net operating income
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800,000
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|
570,000
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Interest expense
|
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122,000
|
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117,000
|
|
|
|
|
|
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Net income before taxes
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678,000
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453,000
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Income taxes (30%)
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203,400
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135,900
|
|
|
|
|
|
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Net income
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474,600
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317,100
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|
|
|
|
|
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Dividends paid:
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|
|
|
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Preferred stock
|
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48,000
|
|
48,000
|
|
Common stock
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62,000
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31,000
|
|
|
|
|
|
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Total dividends paid
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110,000
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79,000
|
|
|
|
|
|
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Net income retained
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364,600
|
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238,100
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Retained earnings, beginning of year
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|
586,100
|
|
348,000
|
|
|
|
|
|
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Retained earnings, end of year
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$
|
950,700
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$
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586,100
|
MarvaRossen, who just two years ago was appointed president of Hedrick Company, admits that the company has been “inconsistent” in its performance over the past several years. But Rossen argues that the company has its costs under control and is now experiencing strong sales growth, as evidenced by the more than 24% increase in sales over the last year. Rossen also argues that investors have recognized the improving situation at Hedrick Company, as shown by the jump in the price of its common stock from $38 per share last year to $54 per share this year. Rossen believes that with strong leadership and with the modernized equipment that the $1,000,000 loan will enable the company to buy, profits will be even stronger in the future.
Anxious to impress your supervisor, you decide to generate all the information you can about the company. You determine that the following ratios are typical of companies in Hedrick’sindustry:
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Current ratio
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2.3
|
|
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Acid-test ratio
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1.2
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|
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Average collection period
|
31.0
|
days
|
|
Average sale period
|
60.0
|
days
|
|
Return on assets
|
9.5
|
%
|
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Debt-to-equity ratio
|
0.65
|
|
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Times interest earned
|
5.7
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|
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Price-earnings ratio
|
10
|
|
Required:
Question 1. You decide first to assess the rate of return that the company is generating. Compute the following for both this year and last year:
a. The return on total assets. (Total assets at the beginning of last year were $4,400,000.)
b. The return on common stockholders’ equity. (Stockholders' equity at the beginning of last year totaled $4,569,320. There has been no change in preferred or common stock over the last two years.)
c. Is the company’s financial leverage positive or negative?
Question 2. You decide next to assess the well-being of the common stockholders. For both this year and last year, compute:
a. The earnings per share.
b. The dividend yield ratio for common stock.
c. The dividend payout ratio for common stock.
d. The price-earnings ratio.
e. The book value per share of common stock.
f. The gross margin percentage.
Question 3. You decide, finally, to assess creditor ratios to determine both short-term and long-term debt paying ability. For both this year and last year, compute:
a. Working capital
b. The current ratio.
c. The acid-test ratio.
d. The average collection period. (The accounts receivable at the beginning of last year totaled $527,000.)
e. The average sale period. (The inventory at the beginning of last year totaled $710,000.)
f. The debt-to-equity ratio.
g. The times interest earned.