L. Konrath Company is considering extending credit to D. Hawk Company. Konrath estimated that sales to D. Hawk Company would amount to $2,000,000 each year. L. Konrath Company, a wholesaler, sells throughout the Midwest. D. Hawk Company, a retail chain operation, has a number of stores in the Midwest. L. Konrath Company has had a gross profit of approximately 60% in recent years and expects to have a similar gross profit on the D.

Hawk Company order. The D. Hawk Company order is approximately 15% of L. Konrath Company's present sales. Data from recent statements of D. Hawk Company are shown on the next page.

(In millions) 1999 2000 2001 Assets Current assets:

Cash $ 2.6 $ 1.8 $ 1.6 Government securities (cost) .4 .2 —

Accounts and notes receivable (net) 8.0 8.5 8.5 Inventories 2.8 3.2 2.8 Prepaid assets .7 .6 .6 Total current assets 14.5 14.3 13.5 Property, plant, and equipment (net) 4.3 5.4 5.9 Total assets $18.8 $19.7 $19.4 Liabilities and Equities Current liabilities $ 6.9 $ 8.5 $ 9.3 Long-term debt, 6% 3.0 2.0 1.0 Total liabilities 9.9 10.5 10.3 Shareholders’ equity 8.9 9.2 9.1 Total liabilities and equities $18.8 $19.7 $19.4 Income Net sales $24.2 $24.5 $24.9 Cost of goods sold 16.9 17.2 18.0 Gross margin 7.3 7.3 6.9 Selling and administrative expenses 6.6 6.8 7.3 Earnings (loss) before taxes .7 .5 (.4)

Income taxes .3 .2 (.2)

Net income $ .4 $ .3 $ (.2)

Required a.Calculate the following for D. Hawk Company for 2001:

1.Rate of return on total assets 4.Current ratio 2.Acid-test ratio 5.Inventory turnover 3.Return on sales b.As part of the analysis to determine whether or not Konrath should extend credit to Hawk, assume the ratios were calculated from Hawk Company statements. For each ratio, indicate whether it is a favorable, unfavorable, or neutral statistic in the decision to grant Hawk credit.

Briefly explain your choice in each case.

Ratio 1999 2000 2001 Rate of return on total assets 1.96% 1.12% (.87)%

Return on sales 1.69% .99% (.69)%

Acid-test ratio 1.73 1.36 1.19 Current ratio 2.39 1.92 1.67 Inventory turnover (times per year) 4.41 4.32 4.52 Equity relationships:

Current liabilities 36.0% 43.0% 48.0%

Long-term liabilities 16.0 10.5 5.0 Shareholders 48.0 46.5 47.0 100.0% 100.0% 100.0%

Asset relationships:

Current assets 77.0% 72.5% 69.5%

Property, plant, and equipment 23.0 27.5 30.5 100.0% 100.0% 100.0%

c.Would you grant credit to D. Hawk Company? Support your answer with facts given in the problem.

d.What additional information, if any, would you want before making a final decision?

CMA Adapted