You have just been hired as a financial analyst for Lydex Company, a manufacture

Question

You have just been hired as a financial analyst for Lydex Company, a manufacturer of safety helmets. Your boss has asked you to perform a comprehensive analysis of the company’s financial statements, including comparing Lydex’s performance to its major competitors. The company’s financial statements for the last two years are as follows:

To begin your assignment you gather the following financial data and ratios that are typical of companies in Lydex Company’s industry:

Required:

1. You decide first to assess the company’s performance in terms of debt management and profitability. Compute the following for both this year and last year: (Round your "Percentage" answers to 1 decimal place and other answers to 2 decimal places.)

a. The times interest earned ratio.

b. The debt-to-equity ratio.

c. The gross margin percentage.

d. The return on total assets. (Total assets at the beginning of last year were $12,970,000.)

e. The return on equity. (Stockholders’ equity at the beginning of last year totaled $7,701,650. There has been no change in common stock over the last two years.)

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

Lydex Company
Comparative Balance Sheet This Year Last Year Assets Current assets: Cash $ 860,000 $ 1,100,000 Marketable securities 0 300,000 Accounts receivable, net 2,300,000 1,400,000 Inventory 3,500,000 2,000,000 Prepaid expenses 240,000 180,000 Total current assets 6,900,000 4,980,000 Plant and equipment, net 9,320,000 8,950,000 Total assets $ 16,220,000 $ 13,930,000 Liabilities and Stockholders' Equity Liabilities: Current liabilities $ 3,910,000 $ 2,780,000 Note payable, 10% 3,600,000 3,000,000 Total liabilities 7,510,000 5,780,000 Stockholders' equity: Common stock, $75 par value 7,500,000 7,500,000 Retained earnings 1,210,000 650,000 Total stockholders' equity 8,710,000 8,150,000 Total liabilities and stockholders' equity $ 16,220,000 $ 13,930,000

Explanation / Answer

Answer a.

This Year:

Times Interest Earned = Net Operating Income / Interest Expense
Times Interest Earned = $1,560,000 / $360,000
Times Interest Earned = 4.33 times

Last Year:

Times Interest Earned = Net Operating Income / Interest Expense
Times Interest Earned = $1,581,000 / $300,000
Times Interest Earned = 5.27 times

Answer b.

This Year:

Debt-to-equity Ratio = Total Liabilities / Total Stockholders’ Equity
Debt-to-equity Ratio = $7,510,000 / $8,710,000
Debt-to-equity Ratio = 0.86

Last Year:

Debt-to-equity Ratio = Total Liabilities / Total Stockholders’ Equity
Debt-to-equity Ratio = $5,780,000 / $8,150,000
Debt-to-equity Ratio = 0.71

Answer c.

This Year:

Gross Margin Percentage = Gross Margin / Sales
Gross Margin Percentage = $3,152,000 / $15,760,000
Gross Margin Percentage = 20.00%

Last Year:

Gross Margin Percentage = Gross Margin / Sales
Gross Margin Percentage = $3,145,000 / $12,580,000
Gross Margin Percentage = 25.00%

Answer d.

This Year:

Average Assets = ($16,220,000 + $13,930,000) / 2
Average Assets = $15,075,000

Return on Total Assets = Net Operating Income * (1 - tax) / Average Assets
Return on Total Assets = $1,560,000 * (1 - 0.30) / $15,075,000
Return on Total Assets = 7.2%

Last Year:

Average Assets = ($13,930,000 + $12,970,000) / 2
Average Assets = $13,450,000

Return on Total Assets = Net Operating Income * (1 - tax) / Average Assets
Return on Total Assets = $1,581,000 * (1 - 0.30) / $13,450,000
Return on Total Assets = 8.2%

Answer e.

This Year:

Average Stockholders’ Equity = ($8,710,000 + $8,150,000) / 2
Average Stockholders’ Equity = $8,430,000

Return on Equity = Net Income / Average Stockholders’ Equity
Return on Equity = $840,000 / $8,430,000
Return on Equity = 10.0%

Last Year:

Average Stockholders’ Equity = ($8,150,000 + $7,701,650) / 2
Average Stockholders’ Equity = $7,925,825

Return on Equity = Net Income / Average Stockholders’ Equity
Return on Equity = $896,700 / $7,925,825
Return on Equity = 11.3%

Answer f.

Financial Leverage = Total Debt / Shareholders’ Equity

Company’s financial leverage is positive in both years.

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