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Chapter 15: Q12RQ (page 835)
Briefly describe the ratios that can be used to evaluate a company’s stock as an investment.
The ratios that can be used for the evaluation of stock as an investment are earnings per share and price-earnings ratio.
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Using ratios to evaluate a stock investment
Comparative financial statement data of Sanfield, Inc. follow:
| SANFIELD, INC. Comparative Income Statement Years Ended December 31, 2018, and 2017 | ||
2018 | 2017 | |
Net Sales Revenue | \( 462,000 | \) 430,000 |
Cost of Goods Sold | 236,000 | 213,000 |
Gross Profit | 226,000 | 217,000 |
Operating Expense | 135,000 | 133,000 |
Income from Operations | 91,000 | 84,000 |
Interest Expense | 8,000 | 12,000 |
Income Before Income Tax | 83,000 | 72,000 |
Income Tax Expense | 18,000 | 22,000 |
Net Income | \( 65,000 | \) 50,000 |
| SANFIELD, INC. Comparative Balance Sheet December 31, 2018, and 2017 | |||
2018 | 2017 | 2016 | |
Asset | |||
Current Assets: | |||
Cash | \( 99,000 | \) 97,000 | |
Accounts Receivable, Net | 109,000 | 117,000 | \( 100,000 |
Merchandise Inventory | 142,000 | 164,000 | 207,000 |
Prepaid Expenses | 15,000 | 5,000 | |
Total Current Assets | 365,000 | 383,000 | |
Property, Plant, and Equipment, Net | 215,000 | 177,000 | |
Total Assets | \) 580,000 | \( 560,000 | \) 599,000 |
Liabilities | |||
Total Current Liabilities | \( 222,000 | \) 244,000 | |
Long-term Liabilities | 113,000 | 92,000 | |
Total Liabilities | 335,000 | 336,000 | |
Stockholders’ Equity | |||
Preferred Stock, 4% | 92,000 | 92,000 | |
Common Stockholders’ Equity, no par | 153,000 | 132,000 | 85,000 |
Total Liabilities and Stockholders’ Equity | \( 580,000 | \) 560,000 | |
1. Market price of Sanfield’s common stock: \(51.48 at December 31, 2018, and \)37.08 at December 31, 2017.
2. Common shares outstanding: 16,000 on December 31, 2018 and 15,000 on December 31, 2017 and 2016.
3. All sales are on credit.
Requirements
1. Compute the following ratios for 2018 and 2017:
2. Decide (a) whether Sanfield’s ability to pay debts and sell inventory improved or deteriorated during 2018 and (b) whether the investment attractiveness of its common stock appears to have increased or decreased.
Using ratios to decide between two stock investments
Assume that you are purchasing an investment and have decided to invest in a company in the digital phone business. You have narrowed the choice to Digitalized Corp. and Every Zone, Inc. and have assembled the following data.
Selected income statement data for the current year:
Digitalized | Every Zone | |
Net sales revenue (all on credit) | \(423,035 | \)493,845 |
Cost of goods sold | 210,000 | 260,000 |
Interest expenses | 0 | 19,000 |
Net income | 51,000 | 72,000 |
Selected balance sheet and market price data at the end of the current year:
Digitalized | Every Zone | |
Current assets: | ||
Cash | \(24,000 | \)17,000 |
Short-term investment | 40,000 | 14,000 |
Accounts receivables, Net | 40,000 | 48,000 |
Merchandise inventory | 66,000 | 97,000 |
Prepaid expenses | 23,000 | 12,000 |
Total current assets | \(193,000 | \)188,000 |
Total assets | 266,000 | 323,000 |
Total current liabilities | 105,000 | 96,000 |
Total liabilities | 105,000 | 128,000 |
Common stock | ||
\(1 par (12,000 shares) | 12,000 | |
\)1 par (17,000 shares) | 17,000 | |
Total stockholders equity | 161,000 | 195,000 |
Market price per share of common stock | 76.50 | 114.48 |
Dividend paid per common stock | 1.10 | 1.00 |
Selected balance sheet data at the beginning of the current year:
Digitalized | Every Zone | |
Balance sheet: | ||
Accounts Receivable, net | \(41,000 | \)54,000 |
Merchandise Inventory | 81,000 | 87,000 |
Total Assets | 261,000 | 272,000 |
Common Stock: | ||
\(1 par (12,000 shares) | 12,000 | |
\)1 par (17,000 shares) | 17,000 |
Your strategy is to invest in companies that have low price/earnings ratios but appear to be in good shape financially. Assume that you have analyzed all other factors and that your decision depends on the results of ratio analysis.
Requirements
a. Acid-test ratio
b. Inventory turnover
c. Days’ sales in receivables
d. Debt ratio
e. Earnings per share of common stock
f. Price/earnings ratio
g. Dividend payout
2. Decide which company’s stock better fits your investment strategy.
Question: Using ratios to decide between two stock investments
Assume that you are purchasing an investment and have decided to invest in a company in the digital phone business. You have narrowed the choice to All Digital Corp. and Green Zone, Inc. and have assembled the following data.
Selected income statement data for the current year:
All digital | Green Zone | |
Net sales revenue (all on credit) | \(417,925 | \)493,115 |
Cost of goods sold | 209,000 | 258,000 |
Interest expenses | 0 | 14,000 |
Net income | 58,000 | 72,000 |
Selected balance sheet and market price data at the end of the current year:
All digital | Green Zone | |
Current assets: | ||
Cash | \(23,000 | \)18,000 |
Short-term investment | 37,000 | 17,000 |
Accounts receivables, Net | 39,000 | 49,000 |
Merchandise inventory | 64,000 | 102,000 |
Prepaid expenses | 21,000 | 17,000 |
Total current assets | \(184,000 | \)203,000 |
Total assets | \(263,000 | \)326,000 |
Total current liabilities | 105,000 | 99,000 |
Total liabilities | 105,000 | 134,000 |
Common stock: | ||
\(1 par (10,000 shares) | 10,000 | |
\)2 par (14,000 shares) | 28,000 | |
Total stockholder’s equity | 158,000 | 192,000 |
Market price per share of common stock | 92.80 | 128.50 |
Dividend paid per common share | 1.20 | 0.90 |
Selected balance sheet data at the beginning of the current year:
All digital | Green Zone | |
Balance sheet: | ||
Accounts receivables, Net | \(41,000 | \)54,000 |
Merchandise inventory | 81,000 | 89,000 |
Total assets | 258,000 | 277,000 |
Common stock: | ||
\(1 par (10,000 shares) | 10,000 | |
\)2 par (14,000 shares) | 28,000 |
Your strategy is to invest in companies with low price/earnings ratios but in good financial shape. Assume that you have analyzed all other factors and that your decision depends on the results of ratio analysis.
Requirements
1. Compute the following ratios for both companies for the current year:
a. Acid-test ratio
b. Inventory turnover
c. Days’ sales in receivables
d. Debt ratio
e. Earnings per share of common stock
f. Price/earnings ratio
g. Dividend payout
2. Decide which company’s stock better fits your investment strategy
The Klein Department Stores, Inc. chief executive officer (CEO) has asked you tocompare the company’s profit performance and financial position with the averages for the industry. The CEO has given you the company’s income statement and balance sheet as well as the industry average data for retailers.
Requirements
1.Prepare a vertical analysis for Klein for both its income statement and balance sheet.
2.Compare the company’s profit performance and financial position with the averagefor the industry.
Theta Designs, Inc. has the following data:
| Theta Designs INC | ||
| Vertical Analysis | ||
| For the year ended December 31, 2017, and 2018 | ||
Assets | 2018 (\() | 2017 (\)) |
Total current assets | 25,000 | 73,440 |
Property, Plant and Equipment, Net | 153,600 | 168,300 |
Other Assets | 21,400 | 64,260 |
Total Assets | 200,000 | 306,000 |
Liabilities | ||
Total current liabilities | 27,600 | 49,266 |
Long term debt | 72,400 | 208,998 |
Total Liabilities | 100,000 | 258,264 |
Stockholders’ Equity | ||
Total stockholders’ Equity | 100,000 | 47,736 |
Total liabilities and stockholders’ equity | 200,000 | 306,000 |
Perform a vertical analysis of Theta Designs’s balance sheet for each year.
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