PROBLEM 15–11 Common-Size Statements and Financial Ratios for Creditors

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PROBLEM 15–11 Common-Size Statements and Financial Ratios for Creditors [LO1, LO3, LO4]

Modern Building Supply sells various building materials to retail outlets. The company has just approached Linden State Bank requesting a $300,000 loan to strengthen the Cash account and to pay certain pressing short-term obligations. The company’s financial statements for the most recent two years follow:
Modern Building Supply
Comparative Balance Sheet
This Year / Last Year
Assets
Current assets:
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 90,000/ $ 200,000
Marketable securities . . . . . . . . . . . . . . . . 0/ 50,000
Accounts receivable, net . . . . . . . . . . . . . . 650,000/ 400,000
Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . 1,300,000/ 800,000
Prepaid expenses . . . . . . . . . . . . . . . . . . . 20,000/ 20,000
Total current assets . . . . . . . . . . . . . . . . . . . 2,060,000/ 1,470,000
Plant and equipment, net . . . . . . . . . . . . . . . 1,940,000 /1,830,000
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . $4,000,000/ $3,300,000
Liabilities and Stockholders’ Equity
Liabilities:
Current liabilities . . . . . . . . . . . . . . . . . . . . $1,100,000/ $ 600,000
Bonds payable, 12% . . . . . . . . . . . . . . . . . 750,000 /750,000
Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . 1,850,000/ 1,350,000
Stockholders’ equity:
Preferred stock, $50 par, 8% . . . . . . . . . . . 200,000 /200,000
Common stock, $10 par . . . . . . . . . . . . . . 500,000 /500,000
Retained earnings . . . . . . . . . . . . . . . . . . . 1,450,000 /1,250,000
Total stockholders’ equity . . . . . . . . . . . . . . . 2,150,000/ 1,950,000
Total liabilities and stockholder’s equity . . . . $4,000,000 /$3,300,000
Modern Building Supply
Comparative Income Statement and Reconciliation
This Year Last Year
Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $7,000,000/ $6,000,000
Cost of goods sold . . . . . . . . . . . . . . . . . . . . 5,400,000/ 4,800,000
Gross margin . . . . . . . . . . . . . . . . . . . . . . . . 1,600,000 /1,200,000
Selling and administrative expenses . . . . . . 970,000 /710,000
Net operating income . . . . . . . . . . . . . . . . . . 630,000/ 490,000
Interest expense . . . . . . . . . . . . . . . . . . . . . . 90,000/ 90,000
Net income before taxes . . . . . . . . . . . . . . . . 540,000/ 400,000
Income taxes (40%) . . . . . . . . . . . . . . . . . . . 216,000/ 160,000
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . 324,000/ 240,000
Dividends paid:
Preferred dividends . . . . . . . . . . . . . . . . . . 16,000 /16,000
Common dividends . . . . . . . . . . . . . . . . . . 108,000/ 60,000
Total dividends paid . . . . . . . . . . . . . . . . . . . 124,000/ 76,000
Net income retained . . . . . . . . . . . . . . . . . . . 200,000 /164,000
Retained earnings, beginning of year . . . . . . 1,250,000/ 1,086,000
Retained earnings, end of year . . . . . . . . . . $1,450,000 /$1,250,000

Problems
706 Chapter 15

During the past year, the company has expanded the number of lines that it carries in order to
stimulate sales and increase profits. It has also moved aggressively to acquire new customers. Sales
terms are 2/10, n/30. All sales are on account.
Assume that the following ratios are typical of companies in the building supply industry:
Current ratio . . . . . . . . . . . . . . . . . 2.5

Acid-test ratio . . . . . . . . . . . . . . . . 1.2
Average collection period . . . . . . . 18 days
Average sale period . . . . . . . . . . . 50 days
Debt-to-equity ratio . . . . . . . . . . . . 0.75
Times interest earned . . . . . . . . . . 6.0
Return on total assets . . . . . . . . . 10%
Price-earnings ratio . . . . . . . . . . . 9
Required:

1. Linden State Bank is uncertain whether the loan should be made. To assist it in making a decision,
you have been asked to compute the following amounts and ratios for both this year and last year:
a. Working capital.
b. Current ratio.
c. Acid-test ratio.
d. Average collection period. (The accounts receivable at the beginning of last year totaled $350,000.)
e. Average sale period. (The inventory at the beginning of last year totaled $720,000.)
f. Debt-to-equity ratio.
g. Times interest earned.
2. For both this year and last year (carry computations to one decimal place):
a. Present the balance sheet in common-size form.
b. Present the income statement in common-size form down through net income.
3. From your analysis in (1) and (2) above, what problems or strengths do you see for Modern
Building Supply? Make a recommendation as to whether the loan should be approved.

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