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4-23 RATIO ANALYSIS Data for Barry Computer Co. and its industry averages follow...
Mar 24, 2024
4-23 RATIO ANALYSIS Data for Barry Computer Co. and its industry averages follow. The firm's debt is priced at par, so the market value of its debt equals its book value. Since dollars are in thousands, the number of shares is shown in thousands too. a. Calculate the indicated ratios for Barry. b. Construct the DuPont equation for both Barry and the industry. c. Outline Barry's strengths and weaknesses as revealed by your analysis. d. Suppose Barry had doubled its sales as well as its inventories, accounts receivable, and common equity during 2021. How would that information affect the validity of your ratio analysis? (Hint: Think about averages and the effects of rapid growth on ratios if averages are not used. No calculations are needed.) Barry Computer Company: Balance Sheet as of December 31, 2021 (in thousands) Cash s 77,500 Accounts payable $129,000\$ 129,000 Receivables Imventories Total current assets 241,500$655,000\frac{241,500}{\$ 655,000} Notes payable to bank Total current liabilities Long-term debt Common equity (36,100(36,100 shares) Net flxed assets 292,500 $947,500\$ 947,500 Total llabilities and equity 117,000 84,000$330,000\frac{84,000}{\$ 330,000} 256,500 361,000 Total assets 947,500 Barry Computer Company: Income Statement for Year Ended December 31, 2021 (in thousands) \ 1,607,500Sales Sales \717,000 717,000 Cost of goods sold Materials 453,000 Labor 68,000 Indirect labor 113,000 Gross profit Selling expenses \begin{aligned} 1,351,0001,351,000 \\\hline\quad 256,500\end{aligned} General and administrative expenses Depreciation Earnings before interest and taxes (EBIT) Interest expense Earnings before taxes (EBT) Federal and state income taxes (25\%) Net income Earnings per share 115,000 Price per share on December 31, 2021 \begin{tabular}{l} 21,000 \\ \hline 549,000\mathbf{5} 49,000 \\ 12,250 \\ $36,750\mathbf{\$} 36,750 \\ \hline$1.018\$ 1.018 \\ $12.00\$ 12.00 \\ \hline \end{tabular} \begin{tabular}{lcc} Ratio & Barry & Industry Average \\ \hline Current & - & 2.0×2.0 \times \\ Quick & - & 1.3×1.3 \times \\ Days sales outstanding & - & 35 days \end{tabular} \begin{tabular}{lcc} Ratio & Barry & Industry Average \\ \hline Inventory turnover & - & 5.7×5.7 \times \\ Total assets turnover & - & 3.0×3.0 \times \\ Profit margin & - & 1.6%1.6 \% \\ ROA & - & 4.8%4.8 \% \\ ROE & - & 12.1%12.1 \% \\ ROIC & - & 9.4%9.4 \% \\ TIE & - & 3.5×3.5 \times \\ Debt/Total capital & - & 47.0%47.0 \% \\ M/B & - & 4.22×4.22 \times \\ P/E & - & 13.27 \\ EV/EBITDA & - & 9.14 \end{tabular} "Calculation is based on a 365 -day year.
Solution by Steps
step 1
To calculate the current ratio, divide total current assets by total current liabilities: Current Ratio=Total Current AssetsTotal Current Liabilities \text{Current Ratio} = \frac{\text{Total Current Assets}}{\text{Total Current Liabilities}}
step 2
From the balance sheet, total current assets are 241,500andtotalcurrentliabilitiesare241,500 and total current liabilities are 117,000: Current Ratio=241,500117,000 \text{Current Ratio} = \frac{241,500}{117,000}
step 3
Perform the division to find the current ratio: Current Ratio=241,500117,000=2.0641 \text{Current Ratio} = \frac{241,500}{117,000} = 2.0641
Answer
Current Ratio for Barry: 2.0641
Key Concept
The current ratio is a liquidity ratio that measures a company's ability to pay short-term obligations.
Explanation
The current ratio is calculated by dividing total current assets by total current liabilities. It provides insight into the company's short-term financial health.
step 1
To construct the DuPont equation for Barry, we need to calculate the Return on Equity (ROE) using the formula: ROE=Profit Margin×Total Asset Turnover×Equity Multiplier \text{ROE} = \text{Profit Margin} \times \text{Total Asset Turnover} \times \text{Equity Multiplier}
step 2
Calculate the profit margin by dividing net income by sales: Profit Margin=Net IncomeSales=36,7501,607,500 \text{Profit Margin} = \frac{\text{Net Income}}{\text{Sales}} = \frac{36,750}{1,607,500}
step 3
Calculate the total asset turnover by dividing sales by total assets: Total Asset Turnover=SalesTotal Assets=1,607,500947,500 \text{Total Asset Turnover} = \frac{\text{Sales}}{\text{Total Assets}} = \frac{1,607,500}{947,500}
step 4
Calculate the equity multiplier by dividing total assets by common equity: Equity Multiplier=Total AssetsCommon Equity=947,500361,000 \text{Equity Multiplier} = \frac{\text{Total Assets}}{\text{Common Equity}} = \frac{947,500}{361,000}
step 5
Perform the calculations for profit margin, total asset turnover, and equity multiplier: Profit Margin=36,7501,607,500=0.0229 \text{Profit Margin} = \frac{36,750}{1,607,500} = 0.0229 Total Asset Turnover=1,607,500947,500=1.6963 \text{Total Asset Turnover} = \frac{1,607,500}{947,500} = 1.6963 Equity Multiplier=947,500361,000=2.6252 \text{Equity Multiplier} = \frac{947,500}{361,000} = 2.6252
step 6
Calculate ROE using the DuPont equation: ROE=0.0229×1.6963×2.6252 \text{ROE} = 0.0229 \times 1.6963 \times 2.6252
step 7
Perform the multiplication to find the ROE: ROE=0.0229×1.6963×2.6252=0.1017 \text{ROE} = 0.0229 \times 1.6963 \times 2.6252 = 0.1017
Answer
ROE for Barry: 10.17%
Key Concept
The DuPont equation is a framework for analyzing the components that drive a company's return on equity (ROE).
Explanation
The DuPont equation breaks down ROE into three parts: profit margin, total asset turnover, and equity multiplier. This analysis helps understand the different factors contributing to the company's financial performance.
step 1
To outline Barry's strengths and weaknesses, compare Barry's ratios to the industry averages and analyze the differences
step 2
Barry's current ratio is higher than the industry average, indicating better short-term financial health
step 3
Barry's ROE is lower than the industry average, suggesting less effective use of equity to generate profits
step 4
Analyze other ratios such as inventory turnover, total assets turnover, and profit margin in comparison to industry averages to identify additional strengths and weaknesses
Answer
Barry's strengths include a higher current ratio than the industry average. Weaknesses include a lower ROE, indicating potential areas for improvement in profitability or asset management.
Key Concept
Ratio analysis helps identify a company's financial strengths and weaknesses by comparing its performance to industry benchmarks.
Explanation
By comparing Barry's financial ratios to industry averages, we can determine areas where the company is performing well and areas where it may need to improve.
step 1
Consider the effects of doubling sales, inventories, accounts receivable, and common equity on the validity of ratio analysis
step 2
Doubling these figures would affect ratios that involve sales, assets, and equity, potentially skewing year-end ratios if not annualized or averaged
step 3
Rapid growth can distort ratios, making it difficult to compare with industry averages or historical performance
step 4
It's important to use averages for such accounts when calculating ratios during periods of rapid growth to maintain comparability and accuracy
Answer
Doubling sales and related accounts would affect the validity of ratio analysis by potentially skewing the results. Using averages can help mitigate this effect.
Key Concept
The effects of rapid growth on financial ratios and the importance of using averages to maintain the validity of ratio analysis.
Explanation
Rapid growth can lead to misleading financial ratios if point-in-time figures are used. Averaging accounts over the period can provide a more accurate representation of the company's financial position.
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