Question $3(50$ marks$)$

Key Financial Data of Dreamscape, Inc.

$\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_$

Dreamscape, Inc. Industry Average

Ratio For the Year Ended For the Year Ended

$(\%$ of Sales$)$ December $31,2001$ December $31,2002$

$\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_$

cost of goods sold $74\mathrm{.}5\%70\mathrm{.}0\%$

gross profits $25\mathrm{.}530\mathrm{.}0$

selling expense $8\mathrm{.}07\mathrm{.}0$

gen. & admin. expense $5\mathrm{.}14\mathrm{.}9$

depreciation expense $2\mathrm{.}42\mathrm{.}0$

total operating expense $15\mathrm{.}513\mathrm{.}9$

operating profits $10\mathrm{.}016\mathrm{.}1$

$4$

interest expense $1\mathrm{.}41\mathrm{.}0$

net profits before taxes $8\mathrm{.}615\mathrm{.}1$

taxes $2\mathrm{.}46\mathrm{.}0$

net profits after taxes $5\mathrm{.}29\mathrm{.}1$

$\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_$

Income Statement

Dreamscape, Inc.

For the Year Ended December $31,2002$

$\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_$

Sales revenue $$1,000,000$

Less: Cost of goods sold $750,000$

$-----------$

Gross profits $ $250,000$

Less: Operating expenses

Selling Expense $$70,000$

Gen. & admin. expense $48,000$

Depreciation expense $20,000$

Total operating expense $ $138,000$

$-----------$

Operating profits $ $112,000$

Less: Interest expense $ $20,000$

$-----------$

Net profits before taxes $ $92,000$

Less: Taxes $ $36,800$

$-----------$

Net profits after taxes $ $55,200$

Required:

Prepare a common$-$size income statement for Dreamscape, Inc. for the year ended December $31,2002.$

Evaluate the company's performance against industry average ratios and against last year's results.

Question $4(10$ marks$)$

Discuss the limitations of ratio analysis and the cautions which must be taken when reviewing a

cross$-$sectional and time$-$series analysis