Calculate the firm's 2003 financial rations and then fill the preceding table.
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Question 1 a: Calculate the firm's 2003 financial rations and then fill the preceding table. Answer: Current ratio = $1,531,181 ? $616,000 = 2.5 Quick ratio = (1,513,181 - $700,625) ? $616,000 = 1.3 Inventory turnover (times) = $3,704,000 ? $700,625 = 5.3 Average collection period = ($805,556 ? $5,075,000) x 360 = 57 days Total asset turnover (times) = $5,075,000 ? $3,125,000 = 1.6 Debt ratio = ($1,781,250 ? $3,125,000) x 100 = 57% Times interest earned ratio = $153,000 ? $93,000 = 1.6 Gross profit margin = ($1,371,000 ? $5,075,000) x 100 = 27% Net profit margin = ($36,000 ? $5,075,000) x 100 = 0.71% Return on total assets (ROA) = ($36,000 ? $3,125,000) x 100 = 1.2% Return on common equity (ROE) = ($36,000 ? $1,343,750) x 100 = 2.7% Price/earning (P/E) ratio = $11.38 ? $0.33 = 34.48 Market/book (M/B) ratio = $1,343,750 - $50,000 100,000 = $12.94 = $11.38 ? $12.94 = 0.88 Martin Manufacturing Company Historical Ratios Ratio Actual 2001 Actual 2002 Actual 2003 Industry Average Current ratio (times) 1.7 1.8 2.5 1.5 Quick ratio (times) 1.0 0.9 1.3 1.2 Inventory turnover (times) 5.2 5.0 5.3 10.2 Average collection period (days) 50 55 57 46 Total asset turnover (times) 1.5 1.5 1.6 2.0 Debt ratio 45.8% 54.3% 57% 24.5% Times interest earned ratio 2.2 1.9 1.6 2.5 Gross profit margin 27.5% 28% 27% 26% Net profit margin 1.1% 1.0% 0.71% 1.2% Return on total assets (ROA)
$5 x 1,600,000 $8,000,000 Total contribution margin $24,000,000 Less: Other costs Movie production $10,000,000 Advertising $5,000,000 $15,000,000 Operating profit $9,000,000 By reducing the selling price by 20% to $20, he anticipated the sales volume to increase to 1,600,000 units from 750,000 units thus registering an increase of 113%. The breakeven point in unit increased to 1,000,000 units. The difference of 250,000 units (1,000,000 - 750,000) in breakeven point represents 33% increase. Based on the anticipated sales the company is expected to generate operating profit of $9,000,000. Julie Wilson's suggestion Breakeven in unit = $10,000,000 + $8,000,000 $25 - $5 = $18,000,000 $20 = 900,000 unit Breakeven in dollars = 900,000 x $25 = $22,500,000 Margin of safety = $37,5000,000 - $22,500,000 x 100 $37,500,000 = 40% Projected Income Statement Sales revenue $25 x 1,500,000 $37,500,000 Less: Total variable cost $5 x 1,500,000 $7,500,000 Total contribution margin $30,000,000 Less: Other costs Movie production $10,000,000 Advertising $8,000,000 $18,000,000 Operating profit $12,000,000 Julie's strategy to increase sales is via aggressive advertising. She anticipated the sales volume to reach 1,500,000 units level, a 100% increase in sales volume as well as in revenue. She explained that the cost will involve an additional $3,000,000 million in advertising cost and still maintain the selling price. The new breakeven point is at 900,000 units' level an increase of 20% from 750,000 units. The company is expected to generate operating profit of $12,000,000. Evaluation of the strategies The strategy of doing nothing should not be adopted as the company would not be generating any profits.
One of such area would be the accruals and deferrals of revenues and expenses. Accrual is defined as recognition of revenue prior to receipt of payment and expenses that incurred and has yet to receive bill. In the case of deferrals, the company is delaying recognition of revenues and expenses. Nevertheless, for each of these a journal entry is required to record the transactions and it is known as "Adjusting Entry". Nest, the financial controller, can accrue revenues and defer expenses and still be ethical under the following circumstances: The fundamental issue that arose from the Xerox case was the revenue recognition concept. It was established in the case that revenues should not be recognised until realised and earned. Therefore based on the above concept, Nest can accrue revenues for works which was completed within the accounting period and has yet to bill the clients. He can also accrue revenue in the form of interest earned from placement of deposits with financial institutions. It can be applied in the event the interest payments due date crosses over into the next accounting period. Nest can accrue interest earned up to the end of the financial year. As in the case of expenses, Nest can defer expenses that are meant for the following financial year. This type of payments is usually termed as prepaid expenses. Some of the expenses that can be deferred are insurance premium and business licence where the payments period of coverage or licence expiry dates falls in the next accounting year. Under these circumstances, the payments should be prorated and the portion meant for the next accounting year can be deferred to the following year.
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