Question & Answer: Paul Sabin organized Sabin Electronics 10 years ago to produce and sell several electronic devices on which he had secured patents…..

Paul Sabin organized Sabin Electronics 10 years ago to produce and sell several electronic devices on which he had secured patents. Although the company has been fairly profitable, it is now experiencing a severe cash shortage. For this reason, it is requesting a $500,000 long-term loan from Gulfport State Bank, $100,000 of which will be used to bolster the Cash account and $400,000 of which will be used to modernize equipment. The company’s financial statements for the two most recent years follow:

Sabin Electronics
Comparative Balance Sheet
This Year Last Year
Assets
Current assets:
Cash $ 70,000 $ 150,000
Marketable securities 0 18,000
Accounts receivable, net 480,000 300,000
Inventory 950,000 600,000
Prepaid expenses 20,000 22,000
Total current assets 1,520,000 1,090,000
Plant and equipment, net 1,480,000 1,370,000
Total assets $ 3,000,000 $ 2,460,000
Liabilities and Stockholders Equity
Liabilities:
Current liabilities $ 800,000 $ 430,000
Bonds payable, 12% 600,000 600,000
Total liabilities 1,400,000 1,030,000
Stockholders’ equity:
Common stock, $15 par 750,000 750,000
Retained earnings 850,000 680,000
Total stockholders’ equity 1,600,000 1,430,000
Total liabilities and equity $ 3,000,000 $ 2,460,000
Sabin Electronics
Comparative Income Statement and Reconciliation
This Year Last Year
Sales $ 5,000,000 $ 4,350,000
Cost of goods sold 3,875,000 3,450,000
Gross margin 1,125,000 900,000
Selling and administrative expenses 653,000 548,000
Net operating income 472,000 352,000
Interest expense 72,000 72,000
Net income before taxes 400,000 280,000
Income taxes (30%) 120,000 84,000
Net income 280,000 196,000
Common dividends 110,000 95,000
Net income retained 170,000 101,000
Beginning retained earnings 680,000 579,000
Ending retained earnings $ 850,000 $ 680,000

During the past year, the company introduced several new product lines and raised the selling prices on a number of old product lines in order to improve its profit margin. The company also hired a new sales manager, who has expanded sales into several new territories. Sales terms are 2/10, n/30. All sales are on account.

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Assume Paul Sabin has asked you to assess his company’s profitability and stock market performance.

Required:

1. You decide first to assess the company’s stock market performance. For both this year and last year, compute:

a. The earnings per share. There has been no change in common stock over the last two years.

b. The dividend yield ratio. The company’s stock is currently selling for $40 per share; last year it sold for $36 per share.

c. The dividend payout ratio.

d. The price-earnings ratio. (Assume that the industry norm for the price-earnings ratio is 12.)

e. The book value per share of common stock.

2. You decide next to assess the company’s profitability. Compute the following for both this year and last year:

a. The gross margin percentage.

b. The net profit margin percentage.

c. The return on total assets. (Total assets at the beginning of last year were $2,420,000.)

d. The return on equity. (Stockholders’ equity at the beginning of last year was $1,420,000.)

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

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