Chapter 13, Problem 4AP

To determine

Compute the following ratios for Corporation C: (1) current ratio, (2) acid-test ratio, (3) days’ sales uncollected, (4) inventory turnover,(5) days’ sales in inventory, (6) debt-to-equity ratio, (7) times interest earned, (8) profit margin ratio, (9) total asset turnover, (10) return on total assets, and (11) return on common stockholders’ equity.

Explanation of Solution

1. 1) Current ratio: Current ratio is one of the liquidity ratios, which measures the capacity of the company to meet its short-term obligations using its current assets. Current ratio is calculated by using the formula:

$\text{Current ratio}=\frac{\text{Current Assets}}{\text{Current Liabilities}}$

Determine the current ratio.

Ratio	Result
Cash	$10,000
Short term investments	$8,400
Accounts receivables, net	$29,200
Current notes receivable (trade)	$4,500
Merchandise inventory	$32,150
Prepaid expenses	$2,650
Current assets (A)	$86,900
Accounts payable	$17,500
Accrued wages payable	$3,200
Income taxes payable	$3,300
Current liabilities (B)	$24,000
Current ratio  $\left(\text{A}\right)÷\left(\text{B}\right)$	3.62:1

Table (1)

Hence, the current ratio is 3.62:1.

1. 2) Acid-test ratio: It is a ratio used to determine a company’s ability to pay back its current liabilities by liquid assets that are current assets except inventory and prepaid expenses.

$\text{Acid-test ratio}=\frac{\text{Quick Assets}}{\text{Current Liabilities}}$

Determine the acid-test ratio.

Ratio	Result
Cash	$10,000
Short term investments	$8,400
Accounts receivables, net	$29,200
Current notes receivable (trade)	$4,500
Quick assets (A)	$52,100
Accounts payable	$17,500
Accrued wages payable	$3,200
Income taxes payable	$3,300
Current liabilities (B)	$24,000
Acid-test ratio  $\left(\text{A}\right)÷\left(\text{B}\right)$	2.2:1

Table (2)

Hence, the acid-test ratio is 2.2:1.

1. 3) Days’ sales uncollected: This ratio is used to determine the number of days a particular company takes to collect accounts receivables.

$\text{Days’ sales uncollected}\text{=}\frac{\text{Ending accounts receivable}}{\text{ Sales}}\times 365\text{days}$

Determine the days’ sales uncollected.

Ratio	Result
Accounts receivables, net	$29,200
Current notes receivable (trade)	$4,500
Ending  net accounts (including notes) receivables (A)	$33,700
Net credit sales (B)	$448,600
Days’ sales uncollected  $\left[\left(\text{A}\right)÷\left(\text{B}\right)\right]\times 365$	27.4 days

Table (3)

Hence, the days’ sales uncollected are 27.4 days.

1. 4) Inventory Turnover Ratio: This ratio is a financial metric used by a company to quantify the number of times inventory is used or sold during the accounting period. It is calculated by using the formula:

   $\text{Inventory turnover}=\frac{\text{Cost of goods sold}}{\text{Average inventory}}$

Determine the inventory turnover ratio.

Ratio	Result
Ending inventory (A)	$32,150
Beginning inventory (B)	$48,900
Total inventory  (C)  $\left(\text{A}\right)+\left(\text{B}\right)$	$81,050
Average inventory (D) $\left(\text{C}\right)÷2$	$40,525
Cost of goods sold (E)	$297,250
Inventory turnover ratio $\left(\text{E}\right)÷\left(\text{D}\right)$	7.3 times

Table (4)

Hence, the inventory turnover ratio is 7.3 times.

1. 5) Days’ sales in inventory: Days’ in inventory is determined as the number of days a particular company takes to make sales of the inventory available with them.

$\text{Days’ in inventory}\text{=}\frac{\text{Ending}\text{Inventory}}{\text{Cost of goods sold}}\times 365\text{days}$

Determine the days’ sales in inventory.

Ratio	Result
Ending inventory (A)	$32,150
Cost of goods sold (B)	$297,250
Days’ sales in inventory$\left[\left(\text{A}\right)÷\left(\text{B}\right)\right]\times 365$	39.5 days

Table (5)

Hence, the days’ sales in inventory are 39.5 days.

1. 6) Debt–to-equity ratio or Debt equity ratio: The debt-to-equity ratio indicates that the company’s debt as a proportion of its stockholders’ equity. The debt-to-equity ratio is calculated using the formula:
   
   

$\text{Debt-to-equity ratio}=\frac{\text{Total liabilities}}{\text{Total stockholders' equity}}$

Determine debt-to-equity ratio.

Ratio	Result
Accounts payable	$17,500
Accrued wages payable	$3,200
Income taxes payable	$3,300
Long term note payable	$63,400
Total liabilities (A)	$87,400
Common stock	$90,000
Retained earnings	$62,800
Total stockholders’ equity (B)	$152,800
Debt-to-Equity ratio  $\left(\text{A}\right)÷\left(\text{B}\right)$	0.57:1

Table (6)

Hence, the debt to equity ratio is 0.57:1.

1. 7) Times interest earned ratio: The times interest earned ratio quantifies the number of times the earnings before interest and taxes can pay the interest expense. First, determine the sum of income before income tax and interest expense. Then, divide the sum by interest expense.

$\begin{array}{l}\text{Times interest}\\ \text{earned ratio}\end{array}\}=\frac{\text{Earnings before interest and taxes expense}}{\text{Interest expense}}$

Determine times interest earned ratio.

Ratio	Result
Net income	$29,052
Interest expense	$4,100
Income taxes	$19,598
Income before interest expense and income taxes (A)	$52,750
Interest expense (B)	$4,100
Times interest earned ratio $\left(\text{A}\right)÷\left(\text{B}\right)$	12.9 times

Table (7)

Hence, the times interest earned ratio is 12.9 times.

1. 8) Profit margin: It is one of the profitability ratios. Profit margin ratio is used to measure the percentage of net income that is being generated per dollar of revenue or sales.

$\text{Profit margin}=\frac{\text{Net income}}{\text{Net sales}}$

Determine profit margin ratio.

Ratio	Result
Net income (A)	$29,052
Net sales (B)	$448,600
Profit margin ratio $\left(\text{A}\right)÷\left(\text{B}\right)$	6.5%

Table (8)

Hence, the profit margin ratio is 6.5%.

1. 9) Total asset turnover: Total asset turnover is a ratio that measures the productive capacity of the total assets to generate the sales revenue for the company. Thus, it shows the relationship between the net sales and the average total assets. Turnover of assets is calculated as follows:

   $\text{Turnover of assets}=\frac{\text{Net sales }}{\text{Average total assets}}$

Determine total asset turnover ratio.

Ratio	Result
Ending total assets (A)	$240,200
Beginning total assets  (B)	$189,400
Average total assets (C) $\left[\left(\text{A}\right)+\left(\text{B}\right)\right]÷2$	$214,800
Net sales (D)	$448,600
Total asset turnover ratio $\left(\text{D}\right)÷\left(\text{C}\right)$	2.1 times

Table (9)

Hence, the total asset turnover ratio is 2.1 times.

1. 10) Return on total assets: Return on total assets is the financial ratio that determines the amount of net income earned by the business with the use of total assets owned by it. It indicates the magnitude of the company’s earnings with relative to its total assets. Return on investment is calculated as follows:

$\text{Return on total assets}=\frac{\text{Net income }}{\text{Average total assets}}$

Determine return on asset ratio.

Ratio	Result
Ending total assets (A)	$240,200
Beginning total assets  (B)	$189,400
Average total assets (C) $\left[\left(\text{A}\right)+\left(\text{B}\right)\right]÷2$	$214,800
Net income (D)	$29,052
Return on asset ratio $\left(\text{D}\right)÷\left(\text{C}\right)$	13.5%

Table (10)

Hence, the return on asset ratio is 13.5%.

Return on common stockholders’ equity ratio: It is a profitability ratio that measures the profit generating ability of the company from the invested money of the shareholders. The formula to calculate the return on equity is as follows:

$\text{Return on equity}=\frac{\text{Net income}}{\text{Average stockholders' equity}}\times 100$

Determine return on common stockholders’ equity ratio.

Ratio	Result
Common stock	$90,000
Retained earnings	$62,800
Ending total stockholders’ equity (A)	$152,800
Common stock	$90,000
Retained earnings	$22,748
Beginning total stockholders’ equity (B)	$112,748
Average common stockholders’ equity (C) $\left[\left(\text{A}\right)+\left(\text{B}\right)\right]÷2$	$132,774
Net income (D)	$29,052
Return on common stockholders’ equity ratio $\left(\text{D}\right)÷\left(\text{C}\right)$	21.9%

Table (11)

Hence, the return on common stockholders’ equity ratio is 21.9%.