Thursday, 2 August 2012

You have just been hired as a loan officer at Fairfield State Bank. Your supervisor has given you a file

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:

Hedrick Company
Comparative Balance Sheet
  This Year Last Year
  Assets         
  Current assets:         
       Cash $ 320,000 $ 420,000   
       Marketable securities   0   100,000   
       Accounts receivable, net   900,000   600,000   
       Inventory   1,300,000   800,000   
       Prepaid expenses   80,000   60,000   
  



  Total current assets   2,600,000   1,980,000   
  Plant and equipment, net   3,100,000   2,980,000   
  



  Total assets $ 5,700,000 $ 4,960,000   
  







  Liabilities and Stockholders Equity         
  Liabilities:         
       Current liabilities $ 1,300,000 $ 920,000   
       Bonds payable, 10%   1,200,000   1,000,000   
  



  Total liabilities   2,500,000   1,920,000   
  



  Stockholders equity:         
       Preferred stock, 8%, $30 par value   600,000   600,000   
       Common stock, $40 par value   2,000,000   2,000,000   
       Retained earnings   600,000   440,000   
  



  Total stockholders equity   3,200,000   3,040,000   
  



  Total liabilities and stockholders equity $ 5,700,000 $ 4,960,000   
  









Hedrick Company
Comparative Income Statement and Reconciliation
  This Year Last Year
  Sales (all on account) $ 5,250,000 $ 4,160,000   
  Cost of goods sold   4,200,000   3,300,000   
  



  Gross margin   1,050,000   860,000   
  Selling and administrative expenses   530,000   520,000   
  



  Net operating income   520,000   340,000   
  Interest expense   120,000   100,000   
  



  Net income before taxes   400,000   240,000   
  Income taxes (30%)   120,000   72,000   
  



  Net income   280,000   168,000   
  



  Dividends paid:         
       Preferred stock   48,000   48,000   
       Common stock   72,000   36,000   
  



  Total dividends paid   120,000   84,000   
  



  Net income retained   160,000   84,000   
  Retained earnings, beginning of year   440,000   356,000   
  



  Retained earnings, end of year $ 600,000 $ 440,000   
  









     Marva Rossen, 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 25% 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 $20 per share last year to $36 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’s industry:

     
  Current ratio 2.3  
  Acid-test ratio 1.2  
  Average collection period 31  days
  Average sale period 60  days
  Return on assets 9.5  %
  Debt-to-equity ratio 0.65  
  Times interest earned 5.7  
  Price-earnings ratio 10  


Required:
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 $4,320,000.) (Round your answers to 1 decimal place. Omit the "%" sign in your response.)

         This year          Last year
  Return on total assets %   %  


b.
The return on common stockholders’ equity. (Stockholders' equity at the beginning of last year totaled $3,016,000. There has been no change in preferred or common stock over the last two years.) (Round your answers to 1 decimal place. Omit the "%" sign in your response.)

     This year    Last year
  Return on common stockholders' equity %   %  


c.
Is the company’s financial leverage positive or negative?

   
  This year Positive  
  Last year Negative  


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. (Round your answers to 2 decimal places. Omit the "$" sign in your response.)

          This year         Last year
  Earnings per share $   $  


b.
The dividend yield ratio for common stock. (Round your intermediate calculations to 2 decimal places and final answers to 1 decimal place. Omit the "%" sign in your response.)

       This year      Last year
  Dividend yield ratio %   %  


c.
The dividend payout ratio for common stock. (Round your intermediate calculations to 2 decimal places and final answers to 1 decimal place. Omit the "%" sign in your response.)

       This year        Last year
  Dividend payout ratio %   %  


d.
The price-earnings ratio. (Round your intermediate calculations to 2 decimal places and final answers to 1 decimal place.)

              This year               Last year
  Price-earnings ratio    


e.
The book value per share of common stock. (Round your intermediate calculations to 2 decimal places and final answers to 1 decimal place. Omit the "$" sign in your response.)

            This year             Last year
  Book value per share $   $  


f.
The gross margin percentage. (Round your intermediate calculations to 2 decimal places and final answers to 1 decimal place. Omit the "%" sign in your response.)

       This year        Last year
  Gross margin percentage %  


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. (Omit the "$" sign in your response.)

             This year              Last year
  Working capital $   $  


b. The current ratio. (Round your answers to 2 decimal places.)

               This year              Last year
  Current ratio  


c. The acid-test ratio. (Round your answers to 2 decimal places.)

               This year              Last year
  Acid-test ratio  


d.
The average collection period. (The accounts receivable at the beginning of last year totaled $520,000.) (Use 365 days in a year. Do not round intermediate calculations. Round your answers to the nearest whole number.)

  This year Last year
  Average collection period days days  


e.
The average sale period. (The inventory at the beginning of last year totaled $640,000.) (Use 365 days in a year. Round your intermediate calculations to 1 decimal places and final answers to the nearest whole number.)

  This year Last year
  Average sale period days days  


f. The debt-to-equity ratio. (Round your answers to 2 decimal places.)

              This year             Last year
  Debt-to-equity ratio  


g. The times interest earned. (Round your answers to 1 decimal place.)

                This year               Last year
  Times interest earned  



Explanation: