QUESTIONS

3. The nature of a company's business, the composition of its

current
assets, and the turnover of its current assets are three
important
factors that should be considered in deciding whether a
current ratio is
good or bad.

Problem 13-2 (120 minutes)

1.
Current ratio: 31 December 2006: $48,480 / $20,200 = 2.4 : 1
31 December 2005: $37,924 / $19,960 = 1.9 : 1
31 December 2004: $50,648 / $19,480 = 2.6 : 1
2.
BENNINGTON COMPANY
COMMON-SIZE COMPARATIVE INCOME STATEMENTS
FOR THE YEARS ENDED 31 DECEMBER 2006, 2005, AND 2004
2006 2005
2004
Sales...........................................................100.00%
100.00% 100.00%
Cost of sales....................................... . . (60.20) (62.50)
(64.00)
Gross profit ............................................ . 39.80
37.50 36.00
Selling expenses................................ (14.12)
(13.80) (13.20)
Administrative expenses .................. . . . . (9.04) (8.80)
(8.25)
Profit before taxes ................................ 16.64
14.90 14.55
Income taxes ...................................... . . . .(3.10)
(3.05) (2.95)
Profit for the period ................................ 13.54%
11.85% 11.60%
3.
BENNINGTON COMPANY
BALANCE SHEET DATA IN TREND PERCENTS
AS AT 31 DECEMBER 2006, 2005, AND 2004

2006 2005 2004

ASSETS
Non-current assets
Plant assets.................................. 157.89% 168.42%
100.00%
Long-term investments ............... 0.00 13.44 100.00
Current assets.................................. 95.72% 74.88%
100.00%
Total assets ...................................... 124.34 120.70
100.00

EQUITY AND LIABILITIES

Equity
Common share............................. 133.33 133.33
100.00
Other contributed capital ............ 150.00 150.00
100.00
Retained earnings........................ 116.91 104.94
100.00
Current liabilities............................. 103.70% 102.46%
100.00%
Total equity and liabilities............... 124.34 120.70
100.00

4.
Significant relations revealed
Bennington’s selling expenses, administrative expenses, and
income taxes
took larger portions of each sales dollar in 2005 than 2004.
However,
because the cost of sales took a smaller portion in 2005, some
efficiency
was gained. In 2006 these trends continued. Selling expenses,
administrative expenses, and income taxes continued to take a
greater
portion of each sales dollar while the gross profit portion
continued to
improve.

Bennington expanded its plant assets in 2005, financing the

expansion
through the sale of long-term investments, through a
reduction in working
capital (the current ratio decreased from 2.6 : 1 to 1.9 : 1), and
perhaps
through the sale of a small amount of share. As to the share
increase, it is
not possible to tell from these two statements whether the
company sold
shares or declared a share dividend. In either case, the
increase in
©McGraw-Hill Companies, Inc., 2007
Solutions Manual, Chapter 13
retained earnings during 2005 indicates that profit was larger
than the
reductions from cash (and perhaps share) dividends. In 2006,
cash
dividends were paid.

Problem AP13-2
1.

a. Gross profit
margin

Company A
$20,000 x 100%
$80,000
= 25%

Company B

$24,000 x 100%
$120,000
= 20%

b. Net profit margin

Company A

$10,000 x 100%
$80,000
= 12.5%

Company B

$15,000 x 100%
$120,000
= 12.5%

c. Inventory turnover

Company A

$60,000
($25,000 + $15,000)/2
= 3 times

Company B

$96,000
($22,500 + $17,500)/2
= 4.8 times

d. Return on
common
shareholder’s
equity

Company A

$10,000 x 100%
($38,000 + $42,000)/2
= 25%

Company B

$15,000 x 100%
($36,000 + $44,000)/2
= 37.5%

e. Current ratio

Company A

$45,000
$5,000
=9:1

Company B

$40,000
$10,000
=4:1

f. Quick ratio

Company A

$30,000
$5,000
=6:1

Company B

$22,500
$10,000
= 2.25 : 1

g. Debt to total
assets ratio

Company A

$5,000
$47,000
= 10.64%

Company B

$10,000
$54,000
= 18.52%

2.
Company B is the most profitable, both in terms of actual
profit for the
period $15,000 compared to $10,000, and also in terms of
capital
employed; B has managed to achieve a return of $37.50 for
every $100
invested, i.e. 37.50. A has managed a lower return of 25%.
Therefore, based on the above analysis, Company B should be
chosen.
REASONS:
(i) Possibly managed to sell far more merchandise because of
lower prices, i.e. took only 20% margin as compared with A’s
25% margin.
(ii) Maybe more than efficient use of merchandise means in the
business. Note he has more equipment, and perhaps as a
consequence kept other expenses down to $6,000 as compared
with A’s $9,000.
(iii) Did not have as much stock lying idle. Inventory turnover
is 4.8
times in the year as compared with 3 times for A.
(iv) A’s current ratio of 9 is far greater than normally needed.
B
kept it down to 4. A, therefore, had too much money lying idle
and not doing anything.
(v) The quick ratio for A is also higher than necessary.
(Other possible REASONS could also be accepted)