PROBLEM 13-9 Computing Financial Ratios for Common Shareholders [LO2 - CC2] CHECK FIGURES (1a) EPS this year: $4.65 (2a) Return on total assets last year: 14.0% (Problems 13-10 and 13-11 delve more deeply into the data presented below. Each problem is independent.) Empire Labs Inc. was organized several years ago to produce and market several new miracle drugs. The company is small but growing, and you are considering the purchase of some of its common shares as an investment. The following data on the company are available for the past two years: EMPIRE LABS INC. Comparative Income Statement For the Years Ended December 31 This Year Last Year Sales $20,000,000 $15,000,000 Less: Cost of goods sold 13,000,000 9,000,000 Gross margin 7,000,000 6,000,000 Less: Operating expenses 5.260.000 4.560.000 Net operating income 1,740,000 1,440,000 Less: Interest expense 240.000 240.000 Net Income before taxes 1,500,000 1,200,000 Less: Income taxes (30%) 450.000 360.000 Net Income $ 1,050,000 $_840,000 EMPIRE LABS INC. Comparative Retained Earnings Statement For the Years Ended December 31 This Year Last Year Retained earnings, January 1 $2,400,000 $1,960,000 Add: Net Income (above) __1.050.000 __840.000 Total 3.450.000 2.800.000 Deduct: Cash dividends paid: Preferred dividends 120,000 120.000 Common dividends 360.000 280.000 Total dividends paid 480.000 400.000 Retained earnings, December 31 $2.970,000 $2.400.000 EMPIRE LABS INC. Comparative Balance Sheet December 31 This Year Last Year Assets Current assets: Cash $ 200,000 $ 400,000 Accounts receivable, net 1,500,000 800,000 Inventory 3,000,000 1,200,000 Prepaid expenses 100.000 100.000 Total current assets 4,800,000 2,500,000 Plant and equipment, net 5.170.000 5.400.000 Total assets $9.970,000 $7.900.000 Liabilities and Shareholders' Equity Liabilities: Current liabilities $2,500,000 $1,000,000 Bonds payable, 12% 2.000.000 2.000.000 Total liabilities 4.500.000 3.000.000 Shareholders' equity: Preferred shares, 8%, $10 par 1,500,000 1,500,000 Common shares, no par (200,000 @ $5) 1,000,000 1,000,000 Retained earnings 2.970,000 2.400.000 Total shareholders' equity 5.470,000 4.900.000 Total liabilities and shareholders' equity $9.970,000 $7.900,000 After some research, you have determined that the following ratios are typical of firms in the pharmaceutical industry: Dividend yield ratio 3% Dividend payout ratio 40% Price earnings ratio 16 Return on total assets 13.5% Return on common equity 20% The company's common shares are currently selling for $60 per share. Last year the shares sold for $45 per share. There has been no change in the preferred or common shares outstanding over the last three years. Required: 1. In analyzing the company, you decide first to compute the earnings per share and related ratios. For both last year and this year, compute the following: a. The earnings per share. b. The dividend yield ratio. c. The dividend payout ratio, d. The price-earnings ratio. e. The book value per common share. f. The gross margin percentage. 2. You decide next to determine the rate of return that the company is generating. For both last year and this year, compute the following: a. The return on total assets. (Total assets were $6,500,000 at the beginning of last year.) b. The return on common shareholders' equity. (Common shareholders' equity was $2.900.000 at the beginning of last Page 679 year.) c. The financial leverage. Is it positive or negative? Explain. 3. On the basis of your work in Requirements (1) and (2), are the company's common shares an attractive investment? Explain
