1. (Liquidity analysis) The Crown Carpet Company has $3,000,000 in cash and a total of $12,000,000 in current assets. The firm's current liabilities equal $6,000,000 such that the firm's current ratio equals 2. The company's managers want to reduce the firm's cash holdings down to $1,000,000 by paying $500,000 in cash to expand the firm's truck fleet and using $1,500,000 in cash to retire a short-term note. If they carry this plan through, what will happen to the firm's current ratio?
2. (Capital structure analysis) The Garner Transport Company currently has net operating income of $500,000 and pays interest expense of $200,000. The company plans to borrow $1 million on which the firm will pay 10 percent interest. The borrowed money will be used to finance an investment that is expected to increase the firm's net operating income by $400,000 a year.
- What is Garner's times interest earned ratio before the loan is taken out and the investment is made?
- What effect will the loan and the investment have on the firm's times interest earned ratio?
3. (Financial statement analysis) Lopez Electronics' management has long viewed TKO Electronics as an industry leader and uses this firm as a model firm for analyzing its own performance. The balance sheets and income statements for the two firms are as follows:
Lopez Electronics, Inc. Balance Sheet ($000) TKO Electronics, Inc. Balance Sheet
Cash $2,000 $1,500
Accounts receivable 4,500 $6,000
Inventories 1,500 2,500
Current assets $8,000 $10,000
Net fixed assets 16,000 25,000
Total assets $24,000 $35,000
Accounts payable $2,500 $5,000
Accrued expenses 1,000 1,500
Short-term notes payable 3,500 1,500
Current liabilities $7,000 $8,000
Long-term debt 8,000 4,000
Owners' equity 9,000 23,000
Total liabilities and owners' equity $24,000 $35,000
Lopez Electronics, Inc. Income Statement ($000) TKO Electronics, Inc. Income Statement ($000)
Net sales (all credit) $48,000 $70,000
Cost of goods sold -36,000 -42,000
Gross profit $12,000 $28,000
Operating expenses -8,000 -12,000
Net operating income $4,000 $16,000
Interest expense -1,150 -550
Earnings before taxes 2,850 15,450
Income taxes (40%) -1,140 -6,180
Net income $1,710 $9,270
1. Calculate the following ratios for both Lopez and TKO:
- Current ratio
- Times interest earned
- Inventory turnover
- Total asset turnover
- Operating profit margin
- Operating return on assets
- Debt ratio
- Average collection period
- Fixed asset turnover
- Return on equity