Chapter 17, Problem P17.35BPGB

To determine

Acid-test Ratio: It is a ratio used to determine a company’s ability to pay back its current liabilities using only liquid assets that are current assets except the inventory and prepaid expenses. Also known as quick ratio, it is a part of liquidity ratios, used for the evaluation of a company’s liquidity.

Inventory Turnover: It is a part of efficiency ratios used during the process of ratio analysis. It reflects the number of times a company’s inventory is converted into sale during a particular period. The cost of goods sold is divided by average inventory to get the value of inventory turnover.

Days’ Sales in Receivables: This ratio is calculated to know the number of days required to collect the payment for credit sales by a company. It is also called average collection period. It reflects the quality of the debtors or accounts receivable a company has. Low value of this ratio reflects that a company is able to convert its credit sale into cash in fewer days.

Debt Ratio: It is the ratio between total assets of thG Company and the total liabilities. Debt ratio reflects the finance strategy of thG Company. It is used to evaluatG Company’s ability to pay its debts. Higher debt ratio implies the higher financial risk.

Earnings per Share: It is a mandatory term to be reported with the financials of a company in the annual report. It reflects the amount earned or lost on each outstanding common equity share. It is widely used to evaluate the performance of a business.

Price/Earnings Ratio: It depicts the relation of market price of a share to earnings per share of that company. The price/earnings ratio shows the market value of the amount invested to earn $1 by a company. It is major tool to be used by investors before the decisions related to investments in a company.

Dividend Payout: After the calculation of earnings per share, companies declare the amount to be paid to common shareholders out of those earnings. This portion of earnings per share declared to be paid as dividends is measure by dividend payout ratio. It is reflected as in percentage of earnings per share.

1.

a.

To Compute: The acid-test ratio of company A and G.

Use below formula to compute acid-test ratio:

$\text{Acid-test Ratio}=\frac{\text{Cash}+\text{Account Receivable}+\text{Short-term Investments}}{\text{Current Liabilities}}$

For A Company:

To determine

b.

To Compute: The inventory turnover of company A and G.

Use below formula to compute inventory turnover:

$\text{Inventory Turnover}=\frac{\text{Cost of Goods Sold}}{\text{Average Merchandise Inventory}}$

For A Company:

Given,

► Cost of goods sold is $209,000.

► Average merchandise inventory is $72,500 (working note).

Substitute $209,000 for cost of goods sold and $72,500 for average merchandise inventory in the above formula:

$\begin{array}{c}\text{Inventory Turnover}=\frac{\$209,000}{\text{\$72,500}}\\ =2.88\text{ Times}\end{array}$

Inventory Turnover of A company is 2.88 times.

Working note:

$\begin{array}{c}\text{Average Merchandise Inventory}=\frac{\text{Opening Balance}+\text{Closing Balance}}{2}\\ =\frac{\$81,000+\$64,000}{2}\\ =\$72,500\end{array}$

For G Company:

Given,

► Cost of goods sold is $258,000.

► Average merchandise inventory is $95,500 (working note).

Substitute $258,000 for cost of goods sold and $95,500 for average merchandise inventory in the above formula:

$\begin{array}{c}\text{Inventory Turnover}=\frac{\$258,000}{\text{\$95,500}}\\ =2.70\text{ Times}\end{array}$

Inventory Turnover of G Company is 2.70 times.

Working note:

$\begin{array}{c}\text{Average Merchandise Inventory}=\frac{\text{Opening Balance}+\text{Closing Balance}}{2}\\ =\frac{\$89,000+\$102,000}{2}\\ =\$95,500\end{array}$

To determine

c.

To Compute: The days’ sales in receivables of company A and G.

To determine

d.

To Compute: The debts ratio of company A and G.

To determine

e.

To Compute: The earnings per share of common equity of company A and G.

To determine

f.

To Compute: The price/earnings ratio of company A and G.

To determine

g.

To Compute: The dividend payout ratio of company A and G.

To determine

2.

To Decide: Which company’s stock is a better fit for investment?