FINANCIAL ANALYSIS

Below are comparative statements of financial position, statement of earnings and other miscellaneous details for MJ Sleep Shop, as well as selected key ratios from

industry on the following page. Use your formula sheet for this question.

MJ Sleep Shop Inc.
Statement of Earnings
For year ended December 31, 2013
(in thousands of dollars)
Net sales………………………………       $3,250
Cost of goods sold ………………..          2,210
Gross profit …………………………..       $1,040
Selling expenses …………………..   $520
General and admin. expenses …      170
Interest expense ……………………        50
Income tax expense ………………      110
Total expenses ……………………..           850
Net income …………………………..          $190

MJ Sleep Shop Inc.
Comparative Statements of Financial Position at December 31
(in thousands of dollars)
2013       2012
Cash       $125           $ 100
Accounts receivable (net)       200           150
Merchandise inventory       400           370
Property, plant and equipment (net)       1,030           1,000
Accounts payable       295           230
Notes payable1       170           190
Mortgage payable2       400           500
Common shares3(a), 3(b)       500           500
Retained earnings       390           200

1. Note payable: $50,000 of the notes payable listed at year end 2012 are due in 2013.
2. Mortgage payable: $100,000 of the mortgage payable at year end 2012 is due in 2013.
3(a). Common shares: 40,000 shares were issued and outstanding throughout fiscal years 2012 and 2013; no shares were issued or repurchased during 2013.
3(b). The average market price per share over fiscal year 2013 was $15.25.

QUESTION 1 – Continued:
The following 2013 industry average information for comparable businesses is also available:

Accounts receivable turnover       10.87
Acid-test ratio       1.42
Basic earnings per share       $    2.79
Book value per common share       $ 18.00
Book value per preferred share               n/a
Current ratio       2.76
Days’ sales in inventory       64.12
Days’ sales uncollected       36.44
Debt ratio (debt to total assets)       40.20%
Dividend yield       14.65%
Equity ratio       59.80%
Gross profit margin       39.82%
Inventory turnover       5.56
Pledged assets to secured liabilities       1.85
Price-earnings ratio       8.47
Profit margin       5.65%
Return on common shareholders’ equity       17.24%
Return on total assets       3.38%
Times interest earned       11.42
Total asset turnover       1.87

Required: (express ratios to two decimal places)

a. Evaluate the company’s short term debt paying ability for the year ended December 31, 2013.
(1) Select and calculate an appropriate ratio.

(2) State whether the result is favorable or unfavorable with respect to Industry.

b. Evaluate how efficiently the company uses its inventory for the year ended December 31, 2013.
(1) Select and calculate an appropriate ratio.

(2) State whether the result is favorable or unfavorable with respect to Industry.

c. Evaluate the company’s profitability of equity for the year ended December 31, 2013.

(1) Select and calculate an appropriate ratio.

(2) State whether the result is favorable or unfavorable with respect to Industry.

d. Evaluate the company’s gross profit earned for each dollar of sales for the year ended December 31, 2013.
(1) Select and calculate an appropriate ratio.

(2) State whether the result is favorable or unfavorable with respect to Industry.

e. Name a ratio not already used that a long-term creditor would be interested in to assess the company’s solvency for the year ended December 31, 2013. Compute

the ratio and determine whether the results are favorable or unfavorable when compared to Industry.

QUESTION 2 – COST FLOW ASSUMPTION
ABC Inc distributes widgets components and has just completed another year of operations. Management is looking forward to finding out what the profit for the year was

because they get paid a bonus based on net income. The accountant has provided them with the following information concerning their inventory for the year:

Beginning Inventory   1,500 units       $31,500
Purchase #1       4,000 units       $88,000
Sale #1       2,000 units
Purchase #2       2,500 units       $57,500
Sale #2       4,000 units
Sale #3       1,700 units

Total revenues for the period were $192,500

Due to over-supply in the industry at year-end the price for the product had fallen to $20 and the company estimates that the costs to ship and sell the product are

$2.50 per unit.

Required:
a. Calculate the gross margin if ABC decides to use the moving average cost flow assumption

b. Calculate the gross margin if ABC decides to use the FIFO cost flow assumption

c. Based on your answers to (a) and (b) which cost flow assumption would management prefer? Why?

d. What is the market value of the inventory for applying the lower of cost and market rule?

e. What value should ABC report on its financial statement for cost of goods sold and ending inventory? Support your answer. Assume they use the direct method

when applying LCM.

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