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Depreciation expense 200,000
Total operating expense 1,200,000
Operating profits $ 1,300,000
Less: Interest expense 200,000
Net profits before taxes $ 1,100,000
Less: Taxes (rate = 40%) 440,000
Net profits after taxes $ 660,000
Less: Preferred stock dividends 50,000
Earnings available for common stockholders $ 610,000

Earnings per share (EPS) $3.05
82 PART 1 Introduction to Managerial Finance


Sterling Company
Balance Sheet
December 31, 2003

Assets Liabilities and Stockholders™ Equity

Current assets Current liabilities
Accounts payableb
Cash $ 200,000 $ 900,000
Marketable securities 50,000 Notes payable 200,000
Accounts receivable 800,000 Accruals 100,000
Inventories 950,000 Total current liabilities $ 1,200,000
Long-term debt (includes financial leases)c
Total current assets $ 2,000,000 $ 3,000,000
Gross fixed assets (at cost)a $12,000,000 Stockholders™ equity
Less: Accumulated depreciation 3,000,000 Preferred stock (25,000 shares, $2 dividend) $ 1,000,000
Common stock (200,000 shares at $3 par)d
Net fixed assets $ 9,000,000 600,000
Other assets $ 1,000,000 Paid-in capital in excess of par value 5,200,000
Total assets $12,000,000 Retained earnings 1,000,000
Total stockholders™ equity $ 7,800,000
Total liabilities and stockholders™ equity $12,000,000
aThe firm has an 8-year financial lease requiring annual beginning-of-year payments of $50,000. Five years of the lease have yet to run.
bAnnual credit purchases of $6,200,000 were made during the year.
cThe annual principal payment on the long-term debt is $100,000.
dOn December 31, 2003, the firm™s common stock closed at $39.50 per share.




Historical and Industry Average Ratios for Sterling Company

Ratio Actual 2001 Actual 2002 Industry average, 2003

Current ratio 1.40 1.55 1.85
Quick ratio 1.00 0.92 1.05
Inventory turnover 9.52 9.21 8.60
Average collection period 45.0 days 36.4 days 35.0 days
Average payment period 58.5 days 60.8 days 45.8 days
Total asset turnover 0.74 0.80 0.74
Debt ratio 0.20 0.20 0.30
Times interest earned ratio 8.2 7.3 8.0
Fixed-payment coverage ratio 4.5 4.2 4.2
Gross profit margin 0.30 0.27 0.25
Operating profit margin 0.12 0.12 0.10
Net profit margin 0.062 0.062 0.053
Return on total assets (ROA) 0.045 0.050 0.040
Return on common equity (ROE) 0.061 0.067 0.066
Earnings per share (EPS) $1.75 $2.20 $1.50
Price/earnings (P/E) ratio 12.0 10.5 11.2
Market/book (M/B) ratio 1.20 1.05 1.10
83
CHAPTER 2 Financial Statements and Analysis


CHAPTER 2 CASE Assessing Martin Manufacturing™s
Current Financial Position

T erri Spiro, an experienced budget analyst at Martin Manufacturing
Company, has been charged with assessing the firm™s financial performance
during 2003 and its financial position at year-end 2003. To complete this assign-
ment, she gathered the firm™s 2003 financial statements, which follow. In addi-
tion, Terri obtained the firm™s ratio values for 2001 and 2002, along with the
2003 industry average ratios (also applicable to 2001 and 2002). These are pre-
sented in the table on page 84.


Martin Manufacturing Company
Balance Sheets

December 31
Assets 2003 2002

Current assets
Cash $ 25,000 $ 24,100
Accounts receivable 805,556 763,900
Inventories 700,625 763,445
Total current assets $1,531,181 $1,551,445
Gross fixed assets (at cost) $2,093,819 $1,691,707
Less: Accumulated depreciation 500,000 348,000
Net fixed assets $1,593,819 $1,343,707
Total assets $3,125,000 $2,895,152

Liabilities and Stockholders™ Equity

Current liabilities
Accounts payable $ 230,000 $ 400,500
Notes payable 311,000 370,000
Accruals 75,000 100,902
Total current liabilities $ 616,000 $ 871,402
Long-term debt $1,165,250 $ 700,000
Total liabilities $1,781,250 $1,571,402
Stockholders™ equity
Preferred stock (2,500 shares, $1.20 dividend) $ 50,000 $ 50,000
Common stock (100,000 shares at $4 par)a 400,000 400,000
Paid-in capital in excess of par value 593,750 593,750
Retained earnings 300,000 280,000
Total stockholders™ equity $1,343,750 $1,323,750
Total liabilities and stockholders™ equity $3,125,000 $2,895,152
aThe firm™s 100,000 outstanding shares of common stock closed 2003 at a price of $11.38
per share.
84 PART 1 Introduction to Managerial Finance


Martin Manufacturing Company
Income Statement
for the Year Ended December 31, 2003

Sales revenue $5,075,000
Less: Cost of goods sold 3,704,000
Gross profits $1,371,000
Less: Operating expenses
Selling expense $650,000
General and administrative expenses 416,000
Depreciation expense 152,000
Total operating expense 1,218,000
Operating profits $ 153,000
Less: Interest expense 93,000
Net profits before taxes $ 60,000
Less: Taxes (rate 40%) 24,000
Net profits after taxes $ 36,000
Less: Preferred stock dividends 3,000
Earnings available for common stockholders $ 33,000

Earnings per share (EPS) $0.33




Martin Manufacturing Company
Historical ratios

Actual Actual Actual Industry average
Ratio 2001 2002 2003 2003

Current ratio 1.7 1.8 1.5
Quick ratio 1.0 0.9 1.2
Inventory turnover (times) 5.2 5.0 10.2
Average collection period 50 days 55 days 46 days
Total asset turnover (times) 1.5 1.5 2.0
Debt ratio 45.8% 54.3% 24.5%
Times interest earned ratio 2.2 1.9 2.5
Gross profit margin 27.5% 28.0% 26.0%
Net profit margin 1.1% 1.0% 1.2%
Return on total assets (ROA) 1.7% 1.5% 2.4%
Return on common equity (ROE) 3.1% 3.3% 3.2%
Price/earnings (P/E) ratio 33.5 38.7 43.4
Market/book (M/B) ratio 1.0 1.1 1.2




Required
a. Calculate the firm™s 2003 financial ratios, and then fill in the preceding table.
b. Analyze the firm™s current financial position from both a cross-sectional and
a time-series viewpoint. Break your analysis into evaluations of the firm™s
liquidity, activity, debt, profitability, and market.
85
CHAPTER 2 Financial Statements and Analysis


c. Summarize the firm™s overall financial position on the basis of your findings
in part b.



WEB EXERCISE Go to Web site www.yahoo.com. On the left side of the Yahoo! home page
WW screen, click on the Finance category under Business and Economy. On the next
W
screen click on Y! Finance.
Using this screen, click on Symbol Lookup and find the symbol for South-
west Airlines. Click on this symbol to find the latest trading data for Southwest
Airlines.

1. What was the selling price for the last sale of Southwest™s common stock?
How much in dollars per share was the change?
2. What was the number of shares sold in this trade?

In the More Info box, you will see Profile. Click on it, and scroll down to Statis-
tics at a Glance.

3. What was the amount of Southwest™s sales? What was its after-tax income?
4. What were Southwest™s earnings per share? What was its book value per
share?
5. How many shares of stock does Southwest have outstanding?
6. What were the values of the following ratios for Southwest?
a. Current ratio
b. Operating profit margin
c. Debt/equity ratio
d. Return on equity
e. What other information would you need to evaluate Southwest™s finan-
cial performance on the basis of these ratios?
7. Find More from Market Guide and click on Ratio Comparisons. Using these
data, summarize Southwest™s performance.




Remember to check the book™s Web site at
www.aw.com/gitman
for additional resources, including additional Web exercises.

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