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

Price: $3.99


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 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 320,000 $ 420,000
Marketable securities . . . . . . . . . . . . . . . . 0 100,000
Accounts receivable, net . . . . . . . . . . . . . . 900,000 600,000
Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . 1,300,000 800,000
Prepaid expenses . . . . . . . . . . . . . . . . . . . 80,000 60,000
Total current assets . . . . . . . . . . . . . . . . . . . 2,600,000 1,980,000
Plant and equipment, net . . . . . . . . . . . . . . . 3,100,000 2,980,000
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . $5,700,000 $4,960,000
Liabilities and Stockholders’ Equity
Liabilities:
Current liabilities . . . . . . . . . . . . . . . . . . . . $1,300,000 $ 920,000
Bonds payable, 10% . . . . . . . . . . . . . . . . . 1,200,000 1,000,000
Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . 2,500,000 1,920,000
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 . . . . . . . . . . . . . . . . . . . 600,000 440,000
Total stockholders’ equity . . . . . . . . . . . . . . . 3,200,000 3,040,000
Total liabilities and stockholders’ equity . . . . $5,700,000 $4,960,000
Hedrick Company
Comparative Income Statement and Reconciliation
This Year Last Year
Sales (all on account) . . . . . . . . . . . . . . . . . . $5,250,000 $4,160,000
Cost of goods sold . . . . . . . . . . . . . . . . . . . . 4,200,000 3,300,000
Gross margin . . . . . . . . . . . . . . . . . . . . . . . . 1,050,000 860,000
Selling and administrative expenses . . . . . . 530,000 520,000
Net operating income . . . . . . . . . . . . . . . . . . 520,000 340,000
Interest expense . . . . . . . . . . . . . . . . . . . . . . 120,000 100,000
Net income before taxes . . . . . . . . . . . . . . . . 400,000 240,000
Income taxes (30%) . . . . . . . . . . . . . . . . . . . 120,000 72,000
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . 280,000 168,000
Dividends paid:
Preferred stock . . . . . . . . . . . . . . . . . . . . . 48,000 48,000
Common stock . . . . . . . . . . . . . . . . . . . . . 72,000 36,000
Total dividends paid . . . . . . . . . . . . . . . . . . . 120,000 84,000
Net income retained . . . . . . . . . . . . . . . . . . . 160,000 84,000
Retained earnings, beginning of year . . . . . . 440,000 356,000
Retained earnings, end of year . . . . . . . . . . $ 600,000 $ 440,000

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 25% 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 $20 per share last year to $36 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’s
industry:

Current ratio . . . . . . . . . . . . . . 2.3
Acid-test ratio . . . . . . . . . . . . . 1.2
Average collection period . . . . 31 days
Average sale period . . . . . . . . 60 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 $4,320,000.)
b. The return on common stockholders’ equity. (Stockholders’ equity at the beginning of
last year totaled $3,016,000. There has been no change in preferred or common stock
over the last two years.)

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. (The accounts receivable at the beginning of last year
totaled $520,000.)
e. The average sale period. (The inventory at the beginning of last year totaled $640,000.)
f. The debt-to-equity ratio.
g. The times interest earned.

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