"35. Given the following financial statements for Jones Corporation and Smith Corporation: a. To which company would you, as credit manager for a supplier, approve theextension of (short-term) trade credit? Why? Compute all ratios before answering. b. In which one would you buy stock? Why?JONES CORPORATIONCurrent Assets LiabilitiesCash ...............................$ 20,000 Accounts payable ...................$100,000Accounts receivable .......80,000 Bonds payable (long-term) .....80,000Inventory ........................50,000Long-Term Assets Stockholders ? Equity Fixed assets ....................$500,000 Common stock .......................$150,000Less: Accumulated Paid-in capital ........................70,000 depreciation .............(150,000) Retained earnings ...................100,000*Net fixed assets ........350,000 Total assets ..............$500,000 Total liabilities and equity $500,000Sales (on credit)...................................................................... $1,250,000 Cost of goods sold .................................................................. 750,000 Gross profit ............................................................................ 500,000 †Selling and administrative expense ................................... 257,000 Less: Depreciation expense .................................................50,000 Operating profit ...................................................................... 193,000 Interest expense ......................................................................8,000 Earnings before taxes ............................................................. 185,000 Tax expense ............................................................................92,500 Net income ............................................................................. $92,500 *Use net fixed assets in computing fixed asset turnover.†Includes $7,000 in lease payments.S3-55 SMITH CORPORATIONCurrent Assets LiabilitiesCash .................................$ 35,000 Accounts payable .................. $ 75,000Marketable securities ......7,500 Bonds payable (long-term) .... 210,000Accounts receivable ........70,000Inventory .........................75,000Long-Term Assets Stockholders ? Equity Fixed assets .....................$500,000 Common stock ....................... $ 75,000Less: Accumulated Paid-in capital ........................ 30,000 depreciation ................(250,000) Retained earnings .................. 47,500*Net fixed assets ...........250,000Total assets .................$437,500 Total liabilities and equity ... $437,500Sales (on credit) ..........................................................$1,000,000Cost of goods sold ...................................................... 600,000Gross profit .................................................................400,000†Selling and administrative expense ......................224,000Less: Depreciation expense ....................................50,000Operating profit ..........................................................126,000Interest expense ..........................................................21,000Earnings before taxes ..................................................105,000Tax expense ................................................................52,500Net income ..................................................................$ 52,500*Use net fixed assets in computing fixed asset turnover.†Includes $7,000 in lease payments.S3-56 3-35. Solution:Jones and Smith ComparisonOne way of analyzing the situation for each company is to compare therespective ratios for each on, examining those ratios which would bemost important to a supplier or short-term lender and a stockholder. Jones Corp. Smith Corp.Profit margin 7.4% 5.25%Return on assets (investments) 18.5% 12.00%Return on equity 28.9% 34.4%Receivable turnover 15.63x 14.29xAverage collection period 23.04 days 25.2 daysInventory turnover 25x 13.3xFixed asset turnover 3.57x 4xTotal asset turnover 2.5x 2.29xCurrent ratio 1.5x 2.5xQuick ratio 1.0x 1.5xDebt to total assets 36% 65.1%Times interest earned 24.13x 6xFixed charge coverage 13.33x 4.75xFixed charge coverage (200/15) (133/28)calculationa. Since suppliers and short-term lenders are most concerned withliquidity ratios, Smith Corporation would get the nod as having thebest ratios in this category. One could argue, however, that Smithhad benefited from having its debt primarily long term rather thanshort term. Nevertheless, it appears to have better liquidity ratios.S3-57 3-35. (Continued)b. Stockholders are most concerned with profitability. In thiscategory, Jones has much better ratios than Smith. Smith does havea higher return on equity than Jones, but this is due to its muchlarger use of debt. Its return on equity is higher than Jones ?because it has taken more financial risk. In terms of other ratios,Jones has its interest and fixed charges well covered and in generalits long-term ratios and outlook are better than Smith ?s. Jones hasset utilization ratios equal to or better than Smith and its lowerliquidity ratios could reflect better short-term asset management,and that point was covered in part a.Note: Remember that to make actual financial decisions more than oneyear ?s comparativeshould also be made.S3-58 COMPREHENSIVE PROBLEMComprehensive Problem 1.Al Thomas has recently been approached by his brother-in-law, Robert Watson, with a proposalto buy a 20 percent interest in Watson Leisure Time Sporting Goods. The company manufacturesgolf clubs, baseball bats, basketball goals, and other similar items.Mr. Watson is quick to point out the increase in sales over the last three years as indicated inthe income statement, Exhibit 1. The annual growth rate is 20 percent. A balance sheet for asimilar time period is shown in Exhibit 2, and selected industry ratios are presented in Exhibit 3.Note the industry growth rate in sales is only approximately 10 percent per year.There was a steady real growth of 2 to 3 percent in gross domestic product during the periodunder study. The rate of inflation was in the 3 to 4 percent range.The stock in the corporation has become available due to the ill health of a currentstockholder, who needs cash. The issue here is not to determine the exact price for the stock, butrather whether Watson Leisure Time Sporting Goods represents an attractive investmentsituation. Although Mr. Thomas has a primary interest in the profitability ratios, he will take aclose look at all the ratios. He has no fast and firm rules about required return on investment, butrather wishes to analyze the overall condition of the firm. The firm does not currently pay a cashdividend, and return to the investor must come from selling the stock in the future. After doing athorough analysis (including ratios for each year and comparisons to the industry), whatcomments and recommendations do you offer to Mr. Thomas?S3-59 "