Problem 14-19 Financial Ratios for Assessing Profitability and Market Performance [LO14-5, LO14-6]

Paul Sabin organized Sabin Electronics 10 years ago to produce and sell several electronic devices on which he had secured patents. Although the company has been fairly profitable, it is now experiencing a severe cash shortage. For this reason, it is requesting a $670,000 long-term loan from Gulfport State Bank, $185,000 of which will be used to bolster the Cash account and $485,000 of which will be used to modernize equipment. The companys financial statements for the two most recent years follow:

Sabin Electronics
Comparative Balance Sheet
	This Year		Last Year
Assets
Current assets:
Cash	$	133,000	$	320,000
Marketable securities		0		14,000
Accounts receivable, net		698,000		470,000
Inventory		1,115,000		765,000
Prepaid expenses		34,000		39,000
Total current assets		1,980,000		1,608,000
Plant and equipment, net		2,015,600		1,380,000
Total assets	$	3,995,600	$	2,988,000
Liabilities and Stockholders Equity
Liabilities:
Current liabilities	$	885,000	$	470,000
Bonds payable, 12%		750,000		750,000
Total liabilities		1,635,000		1,220,000
Stockholders' equity:
Common stock, $20 par		860,000		860,000
Retained earnings		1,500,600		908,000
Total stockholders equity		2,360,600		1,768,000
Total liabilities and stockholders' equity	$	3,995,600	$	2,988,000

Sabin Electronics
Comparative Income Statement and Reconciliation
	This Year		Last Year
Sales	$	5,850,000	$	4,860,000
Cost of goods sold		4,045,000		3,620,000
Gross margin		1,805,000		1,240,000
Selling and administrative expenses		687,000		582,000
Net operating income		1,118,000		658,000
Interest expense		90,000		90,000
Net income before taxes		1,028,000		568,000
Income taxes (30%)		308,400		170,400
Net income		719,600		397,600
Common dividends		127,000		106,000
Net income retained		592,600		291,600
Beginning retained earnings		908,000		616,400
Ending retained earnings	$	1,500,600	$	908,000

During the past year, the company introduced several new product lines and raised the selling prices on a number of old product lines in order to improve its profit margin. The company also hired a new sales manager, who has expanded sales into several new territories. Sales terms are 2/10, n/30. All sales are on account.

Assume Paul Sabin has asked you to assess his companys profitability and stock market performance.

Required:

1. You decide first to assess the companys stock market performance. For both this year and last year, compute:

a. The earnings per share. There has been no change in common stock over the last two years.

b. The dividend yield ratio. The companys stock is currently selling for $60 per share; last year it sold for $50 per share.

c. The dividend payout ratio.

d. The price-earnings ratio. (Assume that the industry norm for the price-earnings ratio is 10)

e. The book value per share of common stock.

2. You decide next to assess the companys profitability. Compute the following for both this year and last year:

a. The gross margin percentage.

b. The net profit margin percentage.

c. The return on total assets. (Total assets at the beginning of last year were $2,948,000.)

d. The return on equity. (Stockholders equity at the beginning of last year was $1,758,000.)

e. Is the companys financial leverage positive or negative?