You have just been hired as a loan officer at Fairfield State Bank A+

You have just been hired as a loan officer at Fairfield State Bank. Your supervisor has given you a file containing a request from Hedrick Company, a manufacturer of auto components, for a $1,000,000 five-year loan. Financial statement data on the company for the last two years are given below:

Hedrick Company

Comparative Balance Sheet

This Year Last Year

Assets

Current assets:

Cash $ 317,000 $ 419,000

Marketable securities 0 106,000

Accounts receivable, net 902,000 599,000

Inventory 1,340,000 740,000

Prepaid expenses 80,000 68,000

Total current assets 2,639,000 1,932,000

Plant and equipment, net 3,535,300 3,171,200

Total assets $ 6,174,300 $ 5,103,200

Liabilities and Stockholders Equity

Liabilities:

Current liabilities $ 1,360,000 $ 840,000

Bonds payable, 10% 1,270,000 1,040,000

Total liabilities 2,630,000 1,880,000

Stockholders equity:

Preferred stock, 8%, $30 par value 600,000 600,000

Common stock, $40 par value 2,000,000 2,000,000

Retained earnings 944,300 623,200

Total stockholders equity 3,544,300 3,223,200

Total liabilities and stockholders equity $ 6,174,300 $ 5,103,200

Hedrick Company

Comparative Income Statement and Reconciliation

This Year Last Year

Sales (all on account) $ 5,260,000 $ 4,330,000

Cost of goods sold 4,000,000 3,210,000

Gross margin 1,260,000 1,120,000

Selling and administrative expenses 520,000 510,000

Net operating income 740,000 610,000

Interest expense 127,000 104,000

Net income before taxes 613,000 506,000

Income taxes (30%) 183,900 151,800

Net income 429,100 354,200

Dividends paid:

Preferred stock 48,000 48,000

Common stock 60,000 30,000

Total dividends paid 108,000 78,000

Net income retained 321,100 276,200

Retained earnings, beginning of year 623,200 347,000

Retained earnings, end of year $ 944,300 $ 623,200

Marva Rossen, who just two years ago was appointed president of Hedrick Company, admits that the company has been “inconsistent” in its performance over the past several years. But Rossen argues that the company has its costs under control and is now experiencing strong sales growth, as evidenced by the more than 20% increase in sales over the last year. Rossen also argues that investors have recognized the improving situation at Hedrick Company, as shown by the jump in the price of its common stock from $37 per share last year to $53 per share this year. Rossen believes that with strong leadership and with the modernized equipment that the $1,000,000 loan will enable the company to buy, profits will be even stronger in the future.

Anxious to impress your supervisor, you decide to generate all the information you can about the company. You determine that the following ratios are typical of companies in Hedrick’sindustry:

Current ratio 2.3

Acid-test ratio 1.2

Average collection period 31.0 days

Average sale period 60.0 days

Return on assets 9.5 %

Debt-to-equity ratio 0.65

Times interest earned 5.7

Price-earnings ratio 10

Required:

1. You decide first to assess the rate of return that the company is generating. Compute the following for both this year and last year:

a. The return on total assets. (Total assets at the beginning of last year were $4,380,000.)

b. The return on common stockholders’ equity.

c. Is the company’s financial leverage positive or negative?

2. You decide next to assess the well-being of the common stockholders. For both this year and last year, compute:

a. The earnings per share.

b. The dividend yield ratio for common stock.

c. The dividend payout ratio for common stock.

d. The price-earnings ratio.

e. The book value per share of common stock.

f. The gross margin percentage.

3. You decide, finally, to assess creditor ratios to determine both short-term and long-term debt paying ability. For both this year and last year, compute:

a. Working capital.

b. The current ratio.

c. The acid-test ratio.

d. The average collection period.

e. The average sale period.

f. The debt-to-equity ratio.

g. The times interest earned.

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