Problem 13-13a

Problem 13-13A Interpretation of Financial Ratios

Being a prudent investor, Sally Perkins always investigates a company thoroughly before purchasing shares of stock for investment. Ms. Perkins is interested in the common stock of Plunge Enterprises. The following data are available for the company:

| Year 3 | Year 2 | Year 1 |

Current ratio…………………………… | 2.8 | 2.5 | 2.0 |

Acid-test ratio…………………………. | 0.7 | 0.9 | 1.2 |

Accounts receivable turnover……… | 8.6 | 9.5 | 10.4 |

Inventory turnover……………………. | 5.0 | 5.7 | 6.8 |

Sales trend…………………………….. | 130.0 | 118.0 | 100.0 |

Dividends paid per share*………….. | $2.50 | $2.50 | $2.50 |

Dividend yield per ratio…………….. | 5% | 4% | 3% |

Dividend payout ratio………………. | 40% | 50% | 60% |

Return on total assets……………… | 13.0% | 11.8% | 10.4% |

Return on common stockholders’ equity………………………………….. | 16.2% | 14.5% | 9.0% |

*There was no change in common stock outstanding over the three-year period.

Ms. Perkins would like answers to a number of questions about the trend of events over the last three years in Plunge Enterprises. Her questions are as follows:

a. Is the market price of the company's stock going up or down?

The marketing price of the company’s stock is going down. The dividends paid per share which is $2.50 remained unchanged over the three- year period, but the dividend yield is going up from 3% in year 1, 4% in year 2 to 5% in year 3.

b. Is the earnings per share increasing or decreasing?

The earnings per share is increasing. Although the dividends paid per share which is $2.50 remained unchanged over the three- year period, but the dividend payout ratio is decreasing from 60% in year 1 to 40% in year 3.

c. Is the price-earnings ratio going up or down?

The price-earnings ratio is going down. If the market price of the stock is going down and earnings per share is going up, then the price earnings ratio must be decreasing.

d. Is the company employing financial leverage to the advantage of the...