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P2-24 IntegrativeComplete ratio analysis Given the following financial statements

(below and on page 96), historical ratios, and industry averages, calculate Sterling

Company's financial ratios for the most recent year. (Assume a 365-day year.)

Analyze its overall financial situation from both a cross-sectional and a time-series

viewpoint. Break your analysis into evaluations of the firm's liquidity, activity, debt,

profitability, and market.

Sterling Company

Income Statement

for the Year Ended December 31, 2009

Sales revenue $10,000,000

Less: Cost of goods sold 7,500,000

Gross profits $ 2,500,000

Less: Operating expenses

Selling expense $300,000

General and administrative expenses 650,000

Lease expense 50,000

Depreciation expense 200,000

Total operating expense 1,200,000

Operating profits $ 1,300,000

Less: Interest expense 200,00

Net profits before taxes $ 1,100,000

Less: Taxes (rate = 40%) 440,000

Net profits after taxes $ 660,000

Less: Preferred stock dividends 50,000

Earnings available for common stockholders 610,000

Earnings per share (EPS) $3.05

Sterling Company

Balance Sheet

December 31, 2009

Assets Liabilities and Stockholders' Equity

Current assets Current liabilities

Cash $ 200,000 Accounts payableb $ 900,000

Marketable securities 50,000 Notes payable 200,000

Accounts receivable 800,000 Accruals 100,000

Inventories950,000 Total current liabilities 1,200,000

Total current assets $ 2,000,000 Long-term debt (includes financial leases) 3,000,000

Gross fixed assets (at cost)a $12,000,000 Stockholders' equity

Less: Accumulated depreciation Preferred stock (25,000 shares, $2 dividend) $ 1,000,000

Net fixed assets $ 9,000,000 Common stock (200,000 shares at $3 par)d 600,000

Other assets 1,000,000 Paid-in capital in excess of par value 5,200,000

Total assets 12,000,000 Retained earnings 1,000,000

Total stockholders' equity 7,800,000

Total liabilities and stockholders' equity 12,000,000

aThe firm has an 8-year financial lease requiring annual beginning-of-year payments of $50,000. Five years of the lease have yet to run.

bAnnual credit purchases of $6,200,000 were made during the year.

cThe annual principal payment on the long-term debt is $100,000.

dOn December 31, 2009, the firm's common stock closed at $39.50 per share.

Historical and Industry Average Ratios for Sterling Company

Ratio Actual 2007 Actual 2008 Industry average, 2009

Current ratio 1.40 1.55 1.85

Quick ratio 1.00 0.92 1.05

Inventory turnover 9.52 9.21 8.60

Average collection period 45.6 days 36.9 days 35.5 days

Average payment period 59.3 days 61.6 days 46.4 days

Total asset turnover 0.74 0.80 0.74

Debt ratio 0.20 0.20 0.30

Times interest earned ratio 8.2 7.3 8.0

Fixed-payment coverage ratio 4.5 4.2 4.2

Gross profit margin 0.30 0.27 0.25

Operating profit margin 0.12 0.12 0.10

Net profit margin 0.062 0.062 0.053

Return on total assets (ROA) 0.045 0.050 0.040

Return on common equity (ROE) 0.061 0.067 0.066

Earnings per share (EPS) $1.75 $2.20 $1.50

Price/earnings (P/E) ratio 12.0 10.5 11.2

Market/book (M/B) ratio 1.20 1.05 1.10