Interpretation of Financial Ratios [LO2, LO3]

Being a prudent investor, Sally Perkins always investigates a company thoroughly before purchasing shares of its stock for investment. Ms. Perkins is interested in the common stock of Plunge Enterprises. The following data are available for the company:

Year 3 Year 2 Year 1 Current ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.8 2.5 2.0 Acid-test ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.7 0.9 1.2 Accounts receivable turnover . . . . . . . . . . . . . . . 8.6 9.5 10.4 Inventory turnover . . . . . . . . . . . . . . . . . . . . . . . 5.0 5.7 6.8 Sales trend . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 130.0 118.0 100.0 Dividends paid per share* . . . . . . . . . . . . . . . . . $2.50 $2.50 $2.50 Dividend yield ratio . . . . . . . . . . . . . . . . . . . . . . . 5% 4% 3%

Dividend payout ratio . . . . . . . . . . . . . . . . . . . . . 40% 50% 60%

Return on total assets . . . . . . . . . . . . . . . . . . . . 13.0% 11.8% 10.4%

Return on common stockholders’ equity . . . . . . 16.2% 14.5% 9.0%

*There were no changes in common stock outstanding over the three-year period.

Ms. Perkins would like answers to a number of questions about the trend of events over the last three years in Plunge Enterprises. Her questions are as follows:

a. Is the market price of the company’s stock going up or down?

b. Is the earnings per share increasing or decreasing?

c. Is the price-earnings ratio going up or down?

d. Is the company employing financial leverage to the advantage of the common stockholders?

e. Is it becoming easier for the company to pay its bills as they come due?

f. Are customers paying their bills at least as fast now as they did in Year 1?

g. Is the total of the accounts receivable increasing, decreasing, or remaining constant?

h. Is the level of inventory increasing, decreasing, or remaining constant?

Required:

Answer each of Ms. Perkins’s questions and explain how you arrived at your answer.