Case Scenario:
Joe and Mary’s Dog Food
Eight years ago Joe and Mary opened up a specialty dog food store just outside of Phoenix, Arizona. They sold both pre-manufactured dog food and custom-made gourmet dog food that they purchased from only one supplier. In the beginning the couple had some rough times, but the business was a success and has grown steadily over the last several years.
During the late 1990’s the stock market had experienced a high growth period and the couple asked their accountant and financial advisor Bob how they could take advantage of the market environment during that time. Bob told them that they could take advantage of it in two ways. First they could issue equity securities in Joe and Mary’s Dog Food. Secondly they could use some of the funds from the stock issue to purchase marketable securities. Joe and Mary decided to expand their operation to a regional business at this time and made the equity issue. The couple issued $782,500 in total equity. They used the proceeds to both expand their business and buy the marketable securities.
The two invested an additional $80,000 of their own money in the company in order to buy 100% of the preferred class stock, which was the only stock that had voting rights. They structured all of the shares of the preferred stock and the common stock to pay equivalent dividends for each of the next 15 years. (If one share of preferred stock paid a dividend of $1 then one share of common stock would pay a dividend of $1.) The couple decided to maintain a balance in retained earnings of 10% of the company’s current year total net income. The remainder of the net income was then paid out in the form of the dividend. In 2001 they paid out a dividend of $777,000, in 2002 of $906,358 and in 2003 of $1,073,922.
After preparing Joe and Mary’s 2000 financial statements Bob told the couple that he was concerned that the market had increased too rapidly over the past several years and recommended several steps that the couple could take in order to not be seriously harmed by a possible market decline. Joe and Mary agreed with Bob and the steps were taken. Bob had made the recommendation before the stock market had begun to decline in value. As you know the markets did sharply decline as Bob had projected they would. As a result of the changes that Bob had suggested the firm was not hurt as badly as many other firms were by the decline.
Convinced in Bob’s abilities the couple again, at the end of 2001, sought out Bob’s advice on how to position their company to be the most profitable. Bob told them that they could return to the strategies that they had successfully used prior to 2001 and the couple did. Again Bob’s advice paid off. Both 2002 and 2003 were record years for the couple. In 2001 they experienced net sales of over $4.86 million and came very close to a net income of $1 million. In 2003 their net sales reached over $5.7 million.
Use the information provided in the case and the attached financial statements to complete the following questions. Some sales and income figures referred to in the text of the case have been rounded for ease of reading. Use the numbers from the provided financial statements to answer the following questions when they differ from those presented in the case.
Problem 1. Create Funds statements for 2001, 2002 and 2003.
Problem 2. Calculate the following ratios for 2000: Current ratio, Quick ratio, Inventory turnover ratio, Gross profit Margin, Net profit margin, ROA, Asset turnover ratio, fixed asset turnover ratio, debt ratio, and the times interest earned ratio.
Problem 3. Calculate the Debt ratio and the current ratio for 2000, 2001, 2002 and 2003. Compare the ratios over the 4-year period and explain any trends you see and any deviations from that trend.
Problem 4. Bob has reason to believe that the company will grow their sales by 10% from 2003 in 2004. Create a budgeted Income Statement for Joe and Mary’s Dog Food Company for 2004. Assume that the cost structure that was in place for the company with regards to fixed cost and interest expense will be the same in 2004 as it was in 2003, and that the firms variable costs will continue to be 40% of total sales. The company is the 35% tax bracket.
Problem 5. What would the company’s dividend payment be for 2004? How much of the dividend was paid out to Joe and Mary if they did not own any shares of the firm’s common stock. Ignore the taxes that would be paid on the dividend payment.
Balance Sheet
Joe and Mary's Dog Food
December 31
|
|
2000
|
2001
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2002
|
2003
|
|
Current Assets
|
|
|
|
|
|
Cash
|
800,000
|
775,000
|
765,000
|
780,000
|
|
Accounts Receivable
|
2,000,000
|
2,750,000
|
3,500,000
|
3,575,000
|
|
Inventory
|
750,000
|
225,000
|
760,000
|
765,000
|
|
Marketable Securities
|
850,000
|
265,000
|
280,000
|
265,000
|
|
Total Current Assets
|
$4,400,000
|
$4,015,000
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$5,305,000
|
$5,385,000
|
|
Fixed Assets
|
|
|
|
|
|
Net Fixed Assets
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$2,700,000
|
$2,650,000
|
$2,600,000
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$2,625,000
|
|
|
|
|
|
|
|
Total Assets
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$7,100,000
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$6,665,000
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$7,905,000
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$8,010,000
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|
Current Liabilities
|
|
|
|
|
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Accounts Payable
|
2,100,000
|
2,170,000
|
2,600,000
|
2,761,000
|
|
Accruals
|
1,300,000
|
1,000,000
|
1,050,000
|
955,000
|
|
Other Current Payables
|
600,000
|
680,000
|
695,000
|
785,500
|
|
Total Current Liabilities
|
$4,000,000
|
$3,850,000
|
$4,345,000
|
$4,501,500
|
|
Long Term Liabilities
|
|
|
|
|
|
Bonds Payable
|
1,000,000
|
1,500,000
|
1,500,000
|
1,500,000
|
|
Notes Payable
|
1,239,500
|
440,460
|
1,168,402
|
1,098,308
|
|
Total Long Term Liabilities
|
$2,239,500
|
$1,940,460
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$2,668,402
|
$2,598,308
|
|
Equity
|
|
|
|
|
|
Preferred Stock
|
80,000
|
80,000
|
80,000
|
80,000
|
|
Common Stock
|
702,500
|
702,500
|
702,500
|
702,500
|
|
Retained Earnings
|
78,000
|
92,040
|
109,098
|
127,692
|
|
Total Equity
|
$860,500
|
$874,540
|
$891,598
|
$910,192
|
|
|
|
|
|
|
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Total Liabilities and Equity
|
$7,100,000
|
$6,665,000
|
$7,905,000
|
$8,010,000
|
Income Statement
Joe and Mary's Dog Food
December 31
|
|
2000
|
2001
|
2002
|
2003
|
|
Net Sales
|
$4,500,000
|
$4,860,000
|
$5,297,400
|
$5,774,166
|
|
COGS
|
1,800,000
|
1,944,000
|
2,118,960
|
2,309,666
|
|
Gross Profit
|
2,700,000
|
2,916,000
|
3,178,440
|
3,464,500
|
|
Fixed Costs
|
1,000,000
|
1,000,002
|
1,000,004
|
1,000,006
|
|
EBIT
|
1,700,000
|
1,915,998
|
2,178,436
|
2,464,494
|
|
Interest Expense
|
500,000
|
500,002
|
500,004
|
500,006
|
|
Taxable Income
|
1,200,000
|
1,415,996
|
1,678,432
|
1,964,488
|
|
Tax Expense
|
420,000
|
495,599
|
587,451
|
687,571
|
|
Net Income
|
$780,000
|
$920,397
|
$1,090,981
|
$1,276,917
|