BUS 331 Practice Problems 2-5 PDF

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Page 88 Problem 37 Jones Corporation’s Ratio: 1. Profit Margin = Net Income/Sales = $92,500/$1,250,000 = 0.074 = 7.4% 2. Return on Asset = Net Income/Total Assets = $92,500/$500,000 = 0.185 = 18.5% 3. Return on Equity = Net Income/Stockholders’ Equity = $92,500/($150,000 +$70,000+ $100,000) = 0.2891 = 28.91% 4. Receivable Turnover = Sales (Credits)/Account Receivable = $1,250,000/$80,000 = 15.625 times 5. Average Collection Period = Accounts Receivable/Average Daily Credit Sales = $80,000/ ($1,250,000/365days) = $80,000/$3424 per day = 23.36 days 6. Inventory Turnover = Sales/Inventory = $1,250,000/$50,000 = 25 times 7. Fixed Asset Turnover = Sales/Fixed Assets = $1,250,000/$350,000 = 3.57 times 8. Total Asset Turnover = Sales/Total Assets = $1,250,000/$500,000 = 2.5 times 9. Current Ratio = Current Assets/Current Liabilities = ($20,000+$80,000+$50,000)/ $100,000 = $150,000/$100,000 = 1.5 times 10. Quick Ratio = (Current Assets - Inventory)/Current Liabilities = [($20,000+$80,000+ $50,000) - $50,000]/$100,000 = $100,000/$100,000 = 1 times 11. Debt to Total Assets = Total Debt/Total Assets = ($100,000+$80,000)/$500,000 = $180,000/$500,000 = 0.36 = 36% 12. Times Interest Earned = Income Before Interest and Taxes/Interest = $193,000/$8,000 = 24.125 times Smith Corporation’s Ratio: 1. Profit Margin = Net Income/Sales = $52500/$1,000,000 = 0.0525 = 5.25% 2. Return on Asset = Net Income/Total Assets = $52500/$437,500 = 12% 3. Return on Equity = Net Income/Stockholders’ Equity = $52500/($75,000+$30,000+ $47,500) = 34.43% 4. Receivable Turnover = Sales (Credits)/Account Receivable = $1,000,000/$70,000 = 14.29 times 5. Average Collection Period = Accounts Receivable/Average Daily Credit Sales = $70,000/ ($1,000,000/365 days) = $70,000/$2739.726per day = 25.55 days 6. Inventory Turnover = Sales/Inventory = $1,000,000/$75,000 = 13.33 times 7. Fixed Asset Turnover = Sales/Fixed Assets = $1,000,000/$250,000 = 4 times 8. Total Asset Turnover = Sales/Total Assets = $1,000,000/$437,500 = 2.29 times 9. Current Ratio = Current Assets/Current Liabilities = ($35,000+$7,500+$70,000+ $75,000)/$75,000 = 2.5 times 10. Quick Ratio = (Current Assets - Inventory)/Current Liabilities = ($35,000+$7,500+ $70,000+$75,000-$75,000)/$75,000 = 1.5 times 11. Debt to Total Assets = Total Debt/Total Assets = ($75,000+$210,000)/$437,500 = 0.65 = 65%

12. Times Interest Earned = Income Before Interest and Taxes/Interest = $126,000/$21,000 = 6 times 37a. As the credit manager for a supplier, I would be more likely to approve the extension of short-term trade credit to Smith Corporation. Because it is a short-term trade credit, it is important to look at both corporation’s liquidity ratio, which compares the ability for the two companies to pay back their short-term liabilities. The current ratio for Smith Corporation is current Assets/Current Liabilities = ($35,000+$7,500+$70,000+$75,000)/$75,000 = 2.5 times which is higher than Jones Corporation that has a current ratio as Current Ratio = Current Assets/Current Liabilities = ($20,000+$80,000+$50,000)/$100,000 = $150,000/$100,000 = 1.5 times. This tells us that Smith Corporation is more liquidity because it has more current assets to pay their current liabilities. Also, looking at their Quick Ratios, it helps us to indicate that Smith Corporation is a better choice because Smith Corporation has a higher Quick Ratio = (Current Assets - Inventory)/Current Liabilities = ($35,000+$7,500+$70,000+$75,000-$75,000)/$75,000 = 1.5 times compare to Jones Corporation is Quick Ratio = (Current Assets - Inventory)/Current Liabilities = [($20,000+$80,000+$50,000) - $50,000]/$100,000 = $100,000/$100,000 = 1 times. However, we should not only use these two ratios to make decisions because the account receivable and inventory is in the current assets that we used to calculate current ratio, and usually people cannot pay their bills (short-term liabilities) with either account receivable or inventory. Instead, we should focus more on the corporation’s cash and marketable securities that every place accepts that people can pay their bills with. By looking at only these two accounts Smith Corporation still has a higher number in the two assets. The total cash and marketable securities Smith has is $42,500 = Cash $35,000 + Marketable Securities $7,500 compared to Jones Corporation with only Cash $20,000 and no Marketable Securities. Even though Smith Corporation has a higher Debt to total assets, which is Total Debt/Total Assets = ($75,000+$210,000)/$437,500 = 0.65 = 65% compare to Jones Corporation with 36% = 0.36 = $180,000/$500,000 = Total Debt/Total Assets, but the higher the debt utilization the company has the higher risk it will have which means there might be a higher return. Also, most of the debt for Smith Corporation is long-term debt which they might not need to pay for a long time and the trade credit we need to decide is short-term. On the other hand, Smith’s Corporation has less short-term liabilities (Account Payable $75,000) compared to Jones Corporation which has $100,000 in Account Payable, which indicates there is a higher chance for Smith Corporation to pay us back. Therefore, we would most likely approve short-term trading credit to Smith Corporation. 37b. We would choose to buy stocks in Jones corporation. The first ratio that easily summarizes the profitability of a company is their profit margins. Jones corporation has a higher profit margin $92,500/$1,250,000 = 0.074 = 7.4% than Smith’s company $52500/$1,000,000 = 0.0525 = 5.25%. This shows that Jone’s company makes more sales to cover its expenses. The

gross profit margin ratio for both companies are both 0.4 (Jones Corporation Gross Margin = Gross Profit/Sales = $500,000/$1,250,000 and Smith Corporation = $400,000/$1,000,000 = 0.4) but after further analysis it shows that Smith’s company paid a large interest expense of $21,000 which might be the reason caused them to have a lower profit margin. Their company has a much higher bonds payable than Jones company showing that they most likely borrowed a large sum of money, increasing the liabilities and interest expense. Earnings drive stock prices and having a higher profit margin usually means the company is more likely to provide better returns for shareholders Jones company also has a higher return on asset and total asset turnover, ROA = Net Income/Sales = $92,500/$500,000 = 0.185 = 18.5% with total asset turnover = sales/total asset = $21,250,000/$500,000 = 2.5 times compared to Smith’s company ROA = Net Income/Total Assets = $52500/$437,500 = 12% with total asset turnover = sales/total asset = $1,000,000/$437,500 = 2.29 times. Having a higher ROA and asset turnover can indicate that the company is more efficient with utilizing its resources and overall making more profits with their resources. Jones company also has a faster inventory turnover of Sales/Inventory = $1,250,000/$50,000 = 25% compared to Smith company with Sales/Inventory = $1,000,000/$75,000 = 13.33% meaning Jones Company is selling its inventory quicker to become sales. Despite Smith’s company having a higher ROE of Net Income/Stockholders’ Equity = $52500/($75,000+$30,000+$47,500) = 34.43% compared to Jones company with Net Income/Stockholders’ Equity = $92,500/($150,000 +$70,000+$100,000) = 28.91% this is because Smith has a higher debt compare to Jones company. It is noticeable that Smith’s company has a high number for their company’s debt to total asset ratio ($75,000+$210,000)/ $437,500 = 0.65 = 65%. Whereas Jone’s company only has ($100,000+$80,000)/$500,000 = $180,000/$500,000 = 0.36 = 36%. A higher debt to total assets ratio indicates that a company carries more debt compared to its total assets meaning their company has more liabilities and is riskier. We must also take into account Smith’s account might be twice as risky. Jones company also has a higher time interest earned showing their more credible with honoring their debts and having the cash to reinvest into the business. This allows the business to continue expanding and generating more profits. As an investor, we would prefer to purchase stock in a more reliable company with higher profits, and lower risk....