Given the financial statements for Jones Corporation and Smith Corporation shown
ID: 1175382 • Letter: G
Question
Given the financial statements for Jones Corporation and Smith Corporation shown here:
a. To which one would you, as credit manager for a supplier, approve the extension of (short-term) trade credit? Why? Compute all ratios before answering.
b. In which one would you buy stock? Why?
JONES CORPORATION
Current Assets
Liabilities
Cash.............................................
$ 20,000
Accounts payable..................
$100,000
Accounts receivable.....................
80,000
Bonds payable (long-term)....
80,000
Inventory......................................
50,000
Long-Term Assets
Stockholders’ Equity
Fixed assets..................................
$500,000
Common stock.......................
$150,000
Less: Accumulated depreciation
(150,000)
Paid-in capital......................
70,000
Net fixed assets*..........................
350,000
Retained earnings.................
100,000
Total assets...............................
$500,000
Total liabilities and equity........
$500,000
Sales (on credit)....................................................................
$1,250,000
Cost of goods sold...............................................................
750,000
Gross profit..........................................................................
500,000
Selling and administrative expense†..................................
257,000
Less: Depreciation expense...............................................
50,000
Operating profit....................................................................
193,000
Interest expense....................................................................
8,000
Earnings before taxes...........................................................
185,000
Tax expense...........................................................................
$ 92,500
Net income............................................................................
$ 92,500
*Use net fixed assets in computing fixed asset turnover.
†Includes $7,000 in lease payments.
SMITH CORPORATION
Current Assets
Liabilities
Cash................................
$ 35,000
Accounts payable..................
$ 75,000
Marketable securities......
7,500
Bonds payable (long-term)....
210,000
Accounts receivable........
70,000
Inventory........................
75,000
Long-Term Assets
Stockholders’ Equity
Fixed assets.....................
$500,000
Common stock......................
$75,000
Less: Accum. dep.........
(250,000)
Paid-in capital........................
30,000
Net fixed assets*............
250,000
Retained earnings..................
47,500
Total assets................
$437,500
Total liab. and equity...........
$437,500
*Use net fixed assets in computing fixed asset turnover.
SMITH CORPORATION
Sales (on credit)....................................................................
$1,000,000
Cost of goods sold................................................................
600,000
Gross profit...........................................................................
400,000
Selling and administrative expense†...................................
224,000
Less: Depreciation expense................................................
50,000
Operating profit....................................................................
126,000
Interest expense....................................................................
21,000
Earnings before taxes............................................................
105,000
Tax expense...........................................................................
52,500
Net income............................................................................
$52,500
†Includes $7,000 in lease payments.
Explanation / Answer
We need to calculate the current ratio of both the firms:
Current ratio = Current Assets / Current Liabilities
Therefore for Smith Current Ratio = (Cash +AR + Inventory) / (AP) = (20000+80000+50000) / 100000 = 150000/100000 = 1.5
For Jones, Current ratio = (Cash +AR + Inventory + Marketable securities) / (AP) = (35000+70000+75000+7500) / 75000 = 187500/75000 = 2.5
Since, Jones has a better current ratio, it is advisable to lend short term finance to Jones. This is because Jones has more current assets to cover his liabilities and will lead to less chance of default in the bank loan. A current ratio of above 2 is favourable.
Fixed asset turnover ratio = Fixed assest / Net sales
The Fixed asset turnover ratio tells us how the assets of the company are being utilised to generate sales and helps in understanding the long term growth of the business.
For Smith, FA TO = 1250 / 350 = 3.57 and for Jones = 1000/250 = 4
This means that Jones is beter utilising its assets to generate sales.
Debt Equity ratio = Total Debt / Total equity
For Smith, Debt Equity Ratio = 80 / (150+70+100) = 0.25 and for Jones = 210 / (75+30+47.5) = 1.38
Since Smith has a lower debt equity ratio, it is advisable to invest in Smith. The FA TO ratio doesnt have a huge difference between the 2 companies, but the lower debt equity ratio signifies lower risk in future and less interest payments.
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.