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Chapter 24: 6E_b (page 1449)

Edna Millay Inc. is a manufacturer of electronic components and accessories with total assets of $20,000,000. Selected financial ratios for Millay and the industry averages for firms of similar size are presented below.

Edna Millay

2017 Industry

2015

2016

2017

Averages

Current ratio

2.09

2.27

2.51

2.24

Quick ratio

1.15

1.12

1.19

1.22

Inventory turnover

2.40

2.18

2.02

3.50

Net sales to stockholders’ equity

2.71

2.80

2.99

2.85

Return on common stockholders’ equity

0.14

0.15

0.17

0.11

Total liabilities to stockholders’ equity

1.41

1.37

1.44

0.95

Millay is being reviewed by several entities whose interests vary, and the company’s financial ratios are a part of the data being considered. Each of the parties listed below must recommend an action based on its evaluation of Millay’s financial position.

Archibald MacLeish Bank. The bank is processing Millay’s application for a new 5-year term note. Archibald MacLeish has been Millay’s banker for several years but must reevaluate the company’s financial position for each major transaction.

Robert Penn Warren. A brokerage firm specializing in the stock of electronics firms that are sold over-the-counter, Robert Penn Warren must decide if it will include Millay in a new fund being established for sale to Robert Penn Warren’s clients.

Working Capital Management Committee. This is a committee of Millay’s management personnel chaired by the chief operating officer. The committee is charged with the responsibility of periodically reviewing the company’s working capital position, comparing actual data against budgets, and recommending changes in strategy as needed.

Instructions

b) For each of the four entities, identify two financial ratios, from the ratios presented above that would be most valuable as a basis for its decision regarding Millay.

Short Answer

Expert verified

The current ratio and Stock turnover ratio.

Step by step solution

01

Meaning of Current Ratio

The current ratio is a measurement of a company's total short-term liquidity as well as its ability to repay short-term debt. It can be found by dividing the current asset by current liabilities.

02

Explaining most valuable as a basis for its decision regarding Millay

The following are two ratios for each of the four compounds used to make Edna Millay Inc.:

The current or quick ratio, as well as the overall liabilities to value ratio, can be used by Archibald MacLeish Bank.

As with stock turnover, the Robert Lowell Corporation can employ either the current or quick ratio,or include the liabilities to equity ratio.

Net transactions can be used to estimate the value and return on common stock equity for its shareholders by Robert Penn Warren.

The current or quick ratio, as well as stock turnover, can be checked by the working capital management committee.

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Most popular questions from this chapter

Cineplex Corporation is a diversified company that operates in five different industries: A, B, C, D, and E. The following information relating to each segment is available for 2018.

A

B

C

D

E

Sales revenue

\(40,000

\)75,000

\(580,000

\)35,000

\(55,000

Cost of goods sold

19,000

50,000

270,000

19,000

30,000

Operating expenses

10,000

40,000

235,000

12,000

18,000

Total expenses

29,000

90,000

505,000

31,000

48,000

Operating profit (loss)

\)11,000

\((15,000)

\)75,000

\(4,000

\)7,000

Identifiable assets

\(35,000

\)80,000

\(500,000

\)65,000

\(50,000

Sales of segments B and C included intersegment sales of \)20,000 and $100,000, respectively.

Instructions

(a) Determine which of the segments are reportable based on the:

  1. Revenue test.

Answer each of the questions in the following unrelated situations.

c) A company has current assets of \(90,000 (of which \)40,000 is inventory and prepaid items) and current liabilities of \(40,000. What is the current ratio? What is the acid-test ratio? If the company borrows \)15,000 cash from a bank on a 120-day loan, what will its current ratio be? What will the acid-test ratio be?

The following statement is an excerpt from the FASB pronouncement related to interim reporting. Interim financial information is essential to provide investors and others with timely information as to the progress of the enterprise. The usefulness of such information rests on the relationship that it has to the annual results of operations. Accordingly, the Board has concluded that each interim period should be viewed primarily as an integral part of an annual period. In general, the results for each interim period should be based on the accounting principles and practices used by an enterprise in the preparation of its latest annual financial statements unless a change in an accounting practice or policy has been adopted in the current year. The Board has concluded, however, that certain accounting principles and practices followed for annual reporting purposes may require modification at interim reporting dates so that the reported results for the interim period may better relate to the results of operations for the annual period.

Instructions

The following six independent cases present how accounting facts might be reported on an individual company’s interim financial reports. For each of these cases, state whether the method proposed to be used for interim reporting would be acceptable under generally accepted accounting principles applicable to interim financial data. Support each answer with a brief explanation.

c) Republic Company wrote inventory down to reflect lower-of-cost-or-market in the first quarter. At year-end, the market exceeds the original acquisition cost of this inventory. Consequently, management plans to write the inventory back up to its original cost as a year-end adjustment.

Picasso Company is a wholesale distributor of packaging equipment and supplies. The company’s sales have averaged about \(900,000 annually for the 3-year period 2015–2017. The firm’s total assets at the end of 2017 amounted to \)850,000.

The president of Picasso Company has asked the controller to prepare a report that summarizes the financial aspects of the company’s operations for the past 3 years. This report will be presented to the board of directors at their next meeting.

In addition to comparative financial statements, the controller has decided to present a number of relevant financial ratios which can assist in the identification and interpretation of trends. At the request of the controller, the accounting staff has calculated the following ratios for the 3-year period 2015–2017.

2015

2016

2017

Current ratio

1.80

1.89

1.96

Acid-test (quick) ratio

1.04

0.99

0.87

Accounts receivable turnover

8.75

7.71

6.42

Inventory turnover

4.91

4.32

3.42

Debt to assets ratio

51.0%

46.0%

41.0%

Long-term debt to assets ratio

31.0%

27.0%

24.0%

Sales to fixed assets (fixed asset turnover)

1.58

1.69

1.79

Sales as a percent of 2015 sales

1.00

1.03

1.07

Gross margin percentage

36.0%

35.1%

34.6%

Net income to sales

6.9%

7.0%

7.2%

Return on assets

7.7%

7.7%

7.8%

Return on common stockholders’ equity

13.6%

13.1%

12.7%

In preparation of the report, the controller has decided first to examine the financial ratios independent of any other data to determine if the ratios themselves reveal any significant trends over the 3-year period.

Instructions

c) Using the ratios provided, what conclusion(s) can be drawn regarding the company’s net investment in plant and equipment?

For each of the following subsequent events, indicate whether a company should (a) adjust the financial statements, (b) disclose in notes to the financial statements, or (c) neither adjust nor disclose.

  1. Settlement of a tax case at a cost considerably in excess of the amount expected at year-end.
  2. Introduction of a new product line.
  3. Loss of assembly plant due to fire.
  4. Sale of a significant portion of the company’s assets.
  5. Retirement of the company president.
  6. Issuance of a significant number of ordinary shares.
  7. Loss of a significant customer.
  8. Prolonged employee strike.
  9. Material loss on a year-end receivable because of a customer’s bankruptcy.
  10. Hiring of a new president.
  11. Settlement of prior year’s litigation against the company (no loss was accrued).
  12. Merger with another company of comparable size.
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