Problem 1 (Financial Statement Analysis)

The financial statements of Duterte Company appear below:

DUTERTE COMPANY
Comparative Balance Sheet
December 31,
———————————————————————————————————————
————
Assets 2019 2018
Cash.................................................................................................... $ 35,000 $ 40,000
Short-term investments...................................................................... 15,000 60,000
Accounts receivable (net).................................................................. 50,000 30,000
Inventory............................................................................................ 50,000 70,000
Property, plant and equipment (net)................................................... 250,000 300,000
Total assets .................................................................................. $400,000 $500,000

Liabilities and stockholders' equity

Accounts payable............................................................................... $ 10,000 $ 30,000
Short-term notes payable................................................................... 40,000 90,000
Bonds payable.................................................................................... 88,000 160,000
Common stock................................................................................... 160,000 145,000
Retained earnings............................................................................... 102,000 75,000
Total liabilities and stockholders' equity..................................... $400,000 $500,000

DUTERTE COMPANY
Income Statement
For the Year Ended December 31, 2019

Net sales............................................................................................. $360,000

Cost of goods sold.............................................................................. 198,000
Gross profit........................................................................................ 162,000
Expenses
Administrative expenses.............................................................. $59,000
Selling expenses........................................................................... 40,000
Interest expense............................................................................ 12,000
Total expenses........................................................................ 111,000
Income before income taxes.............................................................. 51,000
Income tax expense............................................................................ 15,000
Net income......................................................................................... $ 36,000
Additional information:
a. Cash dividends of $9,000 were declared and paid in 2019.
b. Weighted-average number of shares of common stock outstanding during 2019 was 30,000
shares.
c. Market value of common stock on December 31, 2019, was $21 per share.

Instructions
1. Using the financial statements and additional information, compute the following ratios
for DUTERTE Company for 2009. Show all computations.
2. After completing the above requirements, Analyze the results and provide your
comments and insights.
PROBLEM 2

Given the balance sheet and income state for Simmons Maintenance Company, compute the
ratios that are also shown for the industry average. For each ratio, indicate whether Simmons is
better or worse than the industry average.

After completing the above requirements, Analyze the results and provide your comments and
insights.
COMPREHENSIVE PROBLEM
Comprehensive Problem 1.

Al Thomas has recently been approached by his brother-in-law, Robert Watson, with a proposal
to buy a 20 percent interest in Watson Leisure Time Sporting Goods. The company manufactures
golf clubs, baseball bats, basketball goals, and other similar items.
Mr. Watson is quick to point out the increase in sales over the last three years as indicated in
the income statement, Exhibit 1. The annual growth rate is 20 percent. A balance sheet for a
similar time period is shown in Exhibit 2, and selected industry ratios are presented in Exhibit 3.
Note the industry growth rate in sales is only approximately 10 percent per year.
There was a steady real growth of 2 to 3 percent in gross domestic product during the period
under study. The rate of inflation was in the 3 to 4 percent range.
The stock in the corporation has become available due to the ill health of a current
stockholder, who needs cash. The issue here is not to determine the exact price for the stock, but
rather whether Watson Leisure Time Sporting Goods represents an attractive investment
situation. Although Mr. Thomas has a primary interest in the profitability ratios, he will take a
close look at all the ratios. He has no fast and firm rules about required return on investment, but
rather wishes to analyze the overall condition of the firm. The firm does not currently pay a cash
dividend, and return to the investor must come from selling the stock in the future. After doing a
thorough analysis (including ratios for each year and comparisons to the industry), what
comments and recommendations do you offer to Mr. Thomas?
Exhibit 1

WATSON LEISURE TIME SPORTING GOODS

Income Statement
200X 200Y 200Z
Sales (all on credit) $1,500,000 $1,800,000 $2,160,000
.....................................................................
Cost of goods sold 950,000 1,120,000 1,300,000
.....................................................................
Gross profit 550,000 680,000 860,000
.....................................................................
Selling and administrative expense* 380,000 490,000 590,000
.....................................................................
Operating profit 170,000 190,000 270,000
.....................................................................
Interest expense 30,000 40,000 85,000
.....................................................................
Net income before taxes 140,000 150,000 185,000
.....................................................................
Taxes 46,120 48,720 64,850
.....................................................................
Net income $ 93,880 $ 101,280 $ 120,150
.....................................................................
Shares 40,000 40,000 46,000
.....................................................................
Earnings per share $2.35 $2.53 $2.61
.....................................................................
*Includes $20,000 in lease payments for each year.

Exhibit 2
 WATSON LEISURE TIME SPORTING GOODS
Balance Sheet
200X 200Y 200Z
Assets
Cash $ 20,000 $ 30,000 $ 20,000
......................................................................
Marketable securities 30,000 35,000 50,000
......................................................................
Accounts receivable 150,000 230,000 330,000
......................................................................
Inventory 250,000 285,000 325,000
......................................................................
Total current assets.................................. 450,000 580,000 725,000

Net plant and equipment 550,000 720,000 1,169,000

......................................................................
Total assets $1,000,000 $1,300,000 $1,894,000
......................................................................

Liabilities and Stockholders’ Equity

Accounts payable $ 100,000 $ 225,000 $ 200,000
......................................................................
Notes payable (bank) 100,000 100,000 300,000
......................................................................
Total current liabilities............................ 200,000 325,000 500,000

Long-term liabilities 250,000 331,120 550,740

......................................................................
Total liabilities......................................... 450,000 656,120 1,050,740

Common stock ($10 par) 400,000 400,000 460,000

......................................................................
Capital paid in excess of par 50,000 50,000 80,000
......................................................................
Retained earnings 100,000 193,880 303,260
......................................................................
Total stockholders’ equity....................... 550,000 643,880 843,260

Total liabilities and stockholders’ equity $1,000,000 $1,300,000 $1,894,000

......................................................................

Exhibit 3
 Selected Industry Ratios
200X 200Y 200Z

Growth in sales — 9.98% 10.02%

..................................................................
Profit margin 5.75% 5.80% 5.81%
..................................................................
Return on assets (investment) 8.22% 8.24% 8.48%
..................................................................
Return on equity 13.26% 13.62% 14.16%
..................................................................
Receivable turnover 10X 9.5X 10.1X
..................................................................
Average collection period 36 days 37.9 days 35.6 days
..................................................................
Inventory turnover 5.71X 5.62X 5.84X
..................................................................
Fixed asset turnover 2.75X 2.66X 2.20X
..................................................................
Total asset turnover 1.43X 1.42X 1.46X
..................................................................
Current ratio 2.10X 2.08X 2.15X
..................................................................
Quick ratio 1.05X 1.02X 1.10X
..................................................................
Debt to total assets 38% 39.5% 40.1%
..................................................................
Times interest earned 5.00X 5.20X 5.26X
..................................................................
Fixed charge coverage 3.85X 3.95X 3.97X
..................................................................
Growth in EPS — 9.7% 9.8%
..................................................................