Question 1

Modern Services sells various components to maintain on-shore rigs and derricks. The company has just approached Linden State Bank requesting a $300,000 loan to strengthen the Cash account and to pay certain pressing short-term obligations. The company's financial statements for the most recent two years follow:

MODERN SERVICES

Comparative Balance Sheet

AssetsThis YearLast Year

Current assets:

Cash ............................ $ 90,000$ 200,000

Marketable Securities..................050,000

Accounts Receivable, net................650,000400,000

Inventory...................... ...1,300,000800,000

Prepaid Expenses....................20,00020,000

Total Current Assets.......................2,060,0001,470,000

Plant and equipment, net....................1,940,0001,830,000

Total Assets............................4,000,0003,300,000

Liabilities and Stockholders' Equity

Liabilities:

Current Liabilities....................$ 1,100,000$ 600,000

Bonds Payable, 12%..................750,000750,000

Total Liabilities..........................1,850,0001,350,000

Stockholders' Equity:

Preferred Stock, $50 par, 8%.............200,000200,000

Common Stock, $10 par................ 500,000500,000

Retained Earnings...................1,450,0001,250,000

Total Stockholders' Equity...................2,150,0001,950,000

Total Liabilities and Stockholders' Equity...........4,000,0003,300,000

MODERN SERVICES

Comparative Income Statement

AssetsThis YearLast Year

Sales................................$ 7,000,000$ 6,000,000

Less cost of goods sold......................5,400,0004,800,000

Gross margin...........................1,600,0001,200,000

Less operating expenses.....................970,000710,000

Net Operating income......................630,000490,000

Less interest expense.......................90,00090,000

Net income before taxes.....................540,000400,000

Less income taxes (40%).....................216,000160,000

Net income............................324,000240,000

Dividends paid:

Preferred dividends...................16,00016,000

Common dividends.................... 108,00060,000

Total dividends paid........................124,00076,000

Net income retained........................200,000164,000

Retained earnings, beginning of year............... 1,250,0001,086,000

Retained earnings, end of year..................$ 1,450,000$ 1,250,000

During the past year, the company has explained the number of lines that is carries in order to stimulate sales and increase profits. It has also moved aggressively to acquire new customers. Sales terms are 2/10, n/30/. All sales are on account.

Assume that the following ratios are typical of firms in the building supply industry:

Current ratio................ ... 2.5 to 1

Acid-test ratio..................1.2 to 1

Average age of receivables........... 18 days

Inventory turnover in days........... 50 days

Debt-to-equity ratio............... 0.75 to 1

Times interest earned..............6.0 times

Return on total assets..............10%

Price-earnings ratio...............9

Net income as a percentage of sales......4%

Required:

1.Linden State Bank is uncertain whether the loan should be made. To assist it in making a decision, you have been asked to compute the following ratios for both this year and last year:

a.The amount of working capital

b.The current ratio

c.The acid-test ratio

d.The average age of receivables. (The accounts receivable at the beginning of last year totaled $350,000)

e.The inventory turnover in days. (The inventory at the beginning of last year totaled $720,000)

f.The debt-to-equity ratio

g.The number of times interest was earned

2.For both this year and last year (carry computations to one decimal place)

a.Present the balance sheet in common-size form

b.Present the income statement in common-size form down through net income

3.From your analysis in (1) and (2) above, what problems or strengths do you see existing in Modern Services? Make a recommendation as to whether the loan should be approved.