PROBLEM 1–11 The Tristar Mutual Fund manager is considering an investment in the stock of Best Computer and asks for your opinion regarding the company. Best Computer is a computer hardware sales and service company. Approximately 50% of the company’s revenues come from the sale of computer hardware. The rest of the company’s revenues come from hardware service and repair contracts.

Below are financial ratios for Best Computer and comparative ratios for Best Computer’s industry.

The ratios for Best Computer are computed using information from its financial statements.

Best Computer Industry Average Liquidity ratios Current ratio . . . . . . . . . . . . . . . . . . . . 3.45 3.10 Acid-test ratio . . . . . . . . . . . . . . . . . . . 2.58 1.85 Collection period . . . . . . . . . . . . . . . . . 42.19 36.60 Days to sell inventory . . . . . . . . . . . . . 18.38 18.29 Capital structure and solvency Total debt to equity . . . . . . . . . . . . . . . 0.674 0.690 Long-term debt to equity . . . . . . . . . . . 0.368 0.400 Times interest earned . . . . . . . . . . . . . 9.20 9.89 Return on investment Return on assets . . . . . . . . . . . . . . . . . 31.4% 30.0%

Return on common equity . . . . . . . . . . 52.6% 50.0%

Best Computer Industry Average Operating performance Gross profit margin . . . . . . . . . . . . . . . 36.0% 34.3%
Operating profit margin . . . . . . . . . . . 16.7% 15.9%
Pre-tax profit margin . . . . . . . . . . . . . . 14.9% 14.45%
Net profit margin . . . . . . . . . . . . . . . . . 8.2% 8.0%
Asset utilization Cash turnover . . . . . . . . . . . . . . . . . . . 40.8 38.9 Accounts receivable turnover . . . . . . . 6.90 8.15 Sales to inventory . . . . . . . . . . . . . . . . 29.9 28.7 Working capital turnover . . . . . . . . . . . 8.50 9.71 Fixed asset turnover . . . . . . . . . . . . . . 15.30 15.55 Total assets turnover . . . . . . . . . . . . . . 3.94 3.99 Market measures Price-to-earnings ratio . . . . . . . . . . . . 27.8 29.0 Earnings yield . . . . . . . . . . . . . . . . . . . 8.1% 7.9%
Dividend yield . . . . . . . . . . . . . . . . . . . 0% 0.5%
Dividend payout rate . . . . . . . . . . . . . . 0% 2%
Price-to-book . . . . . . . . . . . . . . . . . . . . 8.8 9.0 Required:

a. Interpret the ratios of Best Computer and draw inferences about the company’s financial performance and financial condition—ignore the industry ratios.

b. Repeat the analysis in

(a) with full knowledge of the industry ratios.

c. Indicate which ratios you consider to deviate from industry norms. For each Best Computer ratio that deviates from industry norms, suggest two possible explanations.