You have just been hired as a loan officer at Westmount Bank. Your supervisor has given you a file containing a request from Hill Company, a manufacturer of computer components, for a $2,000,000 five-year loan. Financial statement data on the company for the past two years are give n below:

Pat Smith, who just three years ago was appointed president of Hill Company, admits that the company has been inconsistent in its performance over the past several years. But Smith 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 past year. Smith also argues that investors have recognized the improving situation at Hill Company, as shown by the jump in the price of its common shares from $15 per share last year to $27 per share this year. Smith believes that with strong leadership and with the modernized equipment that the $2,000,000 loan will permit 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 Hill Company's industry:

Required

1. You decide to assess the rate of return that the company is generating first.

a. Compute the return on total assets for both this year and last year. (Total assets at the beginning of last year were $3,240,000.)

b. Compute the return on common shareholders' equity for both this year and last year. (Shareholders' equity at the beginning of last year totalled $2,217,000. There has been no change in preferred or common shares over the past two years.)

c. Is the company's financial leverage positive or negative? Explain.

2. You decide to assess how well the company is doing from the perspective of the common shareholders next. For both this year and last year, compute

a. The earnings per share.

b. The dividend yield ratio for common shares.

c. The dividend payout ratio for common shares.

d. The price-earnings ratio. How do investors regard Hill Company as compared to other companies in the industry? Explain.

e. The book value per common share. Does the difference between market value per share and book value per share suggest that the shares at their current price are a bargain? Explain.

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 totalled $390,000.)

e. The average sale period. (The inventory at the beginning of last year totalled $480,000.)

f. The debt-to-equity ratio.

g. The times interest earned.

4. Recommend to your supervisor whether the loan should be approved.

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HILL COMPANY Comparative Balance Sheet This Year Last Year Assets Current assets: Cash. . ... Temporary investments . Accounts receivable, net . Inventory . . . . .. Prepaid expenses. . Total current assets . Plant and equipment, net. Total assets ... $ 240,000 $ 315,000 75,000 450,000 675,000 975,000 60,000 1,950,000 600,000 45,000 1,485,000 2,235,000 $3,720,000 2,325,000 $4,275,000 Liabilities and Shareholders’ Equity Liabilities: $ 975,000 $ 690,000 Current liabilities Bonds payable, 10% Total liabilities .... 900,000 1,875,000 750,000 1,440,000 Shareholders' equity: Preferred shares, 20,000, $2.40 no par value Common shares, 50,000 .. . . Retained earnings . . Total shareholders' equity. .. Total liabilities and shareholders' equity 450,000 450,000 1,500,000 450,000 1,500,000 330,000 2,280,000 $3,720,000 2,400,000 $4,275,000 HILL COMPANY Comparative Income Statement and Reconciliation of Retained Earnings This Year Last Year Sales (all on account) Cost of goods sold. . ... Gross margin.... Selling and administrative expenses Operating income Interest expense. . $3,937,500 $3,120,000 3,150,000 787,500 2,475,000 645,000 397,500 390,000 390,000 255,000 75,000 180,000 54,000 90,000 300,000 Net income before taxes Income taxes (30%).. 90,000 Net income . 210,000 126,000 Dividends paid: Preferred shares.... 36,000 36,000 27,000 63,000 Common shares. 54,000 Total dividends paid Net income retained ... Retained earnings, beginning of year Retained earnings, end of year 90,000 120,000 63,000 330,000 $450,000 267,000 $330,000