Analysis of Investing Activities ♦ 425
Required:
a.
Calculate expected net income for 2008.
b.
Calculate the percent change in net income. Comment on the company’s use of
operating leverage.
3. Santiago Company reported the following items in its financial statements:
2007
2008
Sales
$ 937,500
$1,125,000
Net income
75,000
135,000
Total assets
3,750,000
4,500,000
Required:
a.
Compute asset turnover, profit margin, and return on assets for each year.
b.
Explain the change in return on assets from 2007 to 2008.
this led to an increase in return on assets.
Gross margin
Operating income
Interest expense
Pretax income
Income tax expense (30%)
Net income
b.
Percentage change in net income = ($676 – $420) ÷ $420 = 60.95%
sales up to a 60.95% increase in profits. Since this is only an expected result, risk is
426 ♦ Chapter 12
4. Turetzky Corporation is considering two alternatives to improve its financial results:
1.
Improve its product quality, resulting in an 8% increase in expenses and a 10%
increase in sales.
2.
Purchase new productive assets for $3 million. This alternative would increase sales
by $4 million and increase expenses by $2,800,000.
Turetzky had the following results for 2007
Sales
$18,000,000
Expenses
15,100,000
Net income
$ 2,900,000
Total assets
$12,000,000
Required:
a.
Compute profit margin, asset turnover, and return on assets for 2007.
b.
Compute profit margin, asset turnover, and return on assets under alternative 1.
c.
Compute profit margin, asset turnover, and return on assets under alternative 2.
d.
Discuss which alternative would be preferable and why.
Sales
Expenses
Net income
Total assets
Asset turnover (ATO)
Profit margin (PM)
Return on assets (ROA)
Analysis of Investing Activities ♦ 427
5. Information is provided below for two companies for 2007:
Kemper
Gong
Total assets
$100,000
$200,000
Total debt
40,000
120,000
Sales
120,000
250,000
Fixed costs
60,000
120,500
Variable costs
48,000
80,000
Net income
12,000
49,500
Required:
a.
Compute profit margin, asset turnover, and return on assets.
b.
Compute profit margin, asset turnover, and return on assets for both firms if sales
increased by 10%.
c.
Compute profit margin, asset turnover, and return on assets for both firms if sales
decreased by 10%.
d.
Discuss the impact on the ROA.
428 ♦ Chapter 12
6. During 2007, Merrill Corporation had $30 million in sales. Return on assets was 18% and asset
turnover was 1.5.
Required:
Compute (a) profit margin, (b) total assets, and (c) net income.
7. At the end of 2007, Camille Company had $150 million total assets. Return on assets was 18%
and profit margin was 6%.
Required:
Compute (a) asset turnover, (b) sales, and (c) net income.
(a)
Asset turnover = 3.0 = 18% / 6%
8. Turbonics Company reported the following items in its financial statements:
2007
2008
Sales
$1,248,000
$1,485,000
Net income
150,000
195,000
Total assets
960,000
1,350,000
Required:
a.
Compute asset turnover, profit margin, and return on assets for each year.
b.
Explain the change in return on assets from 2007 to 2008.
Asset turnover
Profit margin
(a)
Profit margin = 12% = 18% / 1.5
(b)
Total assets = $20 million = $30 / 1.5
Analysis of Investing Activities ♦ 429
9. Zypher Corporation is considering two alternatives to improve its financial results:
a.
Improve its product quality, resulting in a 7% increase in expenses and a 9% increase
in sales.
b.
Purchase new productive assets for $2 million. This alternative would increase sales
by $3.6 million and increase expenses by $2,560,000.
Zypher had the following results for 2007:
Sales
$16,000,000
Expenses
14,800,000
Net income
$ 1,200,000
Total assets
$10,000,000
Required:
a.
Compute profit margin, asset turnover, and return on assets for 2007.
b.
Compute profit margin, asset turnover, and return on assets under alternative 1.
c.
Compute profit margin, asset turnover, and return on assets alternative 2.
d.
Discuss which alternative would be preferable and why.
Sales
Expenses
Net income
Total assets
Asset turnover
Profit margin
Return on assets
430 ♦ Chapter 12
10. Information is provided below for two companies for 2007
Corelle
Padron
Total assets
$160,000
$300,000
Sales
140,000
540,000
Fixed costs
70,000
378,000
Other expenses*
42,000
108,000
Net income
$28,000
$54,000
* Vary in proportion to sales
Required:
a.
Compute profit margin, asset turnover, and return on assets.
b.
Compute profit margin, asset turnover, and return on assets for both firms if sales
increased by 10%.
c.
Compute profit margin, asset turnover, and return on assets for both firms if sales
decreased by 10%.
Analysis of Investing Activities ♦ 431
11. During 2007, Marlon Company had $40 million sales. Return on assets was 20% and asset
turnover was 1.25.
Required:
Compute (a) profit margin, (b) total assets, and (c) net income.
12. At the end of 2007, Presley Company had $200 million total assets. Return on assets was 15% and
profit margin was 8%.
Required:
Compute (a) asset turnover, (b) sales, and (c) net income.
(a)
Asset turnover = 1.875 = 15% / 8%
(b)
Sales = $375 million = $200 × 1.875
(c)
Net income = $30 million = $375 × 8%
13. The following information is available for Sawyer Company:
2007
2008
Sales
$6,000,000
$7,110,000
Operating expenses
1,000,000
2,250,000
Net income
3,375,000
4,000,000
Average assets
7,500,000
10,000,000
Average liabilities
6,000,000
7,500,000
Stockholders’ equity
1,500,000
2,500,000
Required:
a.
Calculate return on assets (ROA) for each year.
b.
Calculate profit margin and asset turnover for each year.
c.
Discuss the reasons for the change in ROA from 2007 to 2008.
(a)
Profit margin = 16% = 20% / 1.25
(b)
Total assets = $32 million = $40 / 1.25
432 ♦ Chapter 12
14. The following information is available for China Grove Company:
2008
2007
Sales
$9,000,000
$ 7,500,000
Operating expenses
1,500,000
1,200,000
Net income
4,500,000
2,250,000
Total assets
15,000,000
12,500,000
Total liabilities
8,000,000
7,000,000
Stockholders’ equity
7,000,000
5,500,000
Required:
a.
Calculate return on assets (ROA) for each year.
b.
Calculate profit margin and asset turnover for each year.
c.
Discuss the reasons for the change in ROA from 2007 to 2008.
= Net Income ÷ Total Assets
2007 ROA
= $2,250,000 ÷ $12,500,000
= 0.18
2008 ROA
= $4,500,000 ÷ $15,000,000
= 0.30
b.
Profit Margin
= Net Income ÷ Sales
2007 Profit Margin
= $2,250,000 ÷ $7,500,000
= 0.30
Asset Turnover
= Sales ÷ Total Assets
2007 Asset Turnover
= $7,500,000 ÷ $12,500,000
= 0.60
2008 Asset Turnover
= $9,000,000 ÷ $15,000,000
= 0.60
2007:
ROA = $3,375,000 ÷ 7,500,000 = 45%
b.
2007
Profit Margin = $3,375,000 ÷ $6,000,000 = 56.25%
Asset Turnover = $6,000,000 ÷ $7,500,000 = 80%
2008
Profit Margin = $4,000,000 ÷ $7,110,000 = 56.26%
Asset Turnover = $7,110,000 ÷ $10,000,000 = 71.1%
turnover. Thus, the firm is not using assets effectively to generate sales.
Analysis of Investing Activities ♦ 433
15. The following information is available for Vectronix Company:
(in millions)
2005
Current assets
$2,000
Property, plant, & equipment (net)
2,500
Other long-term assets
500
Current liabilities
500
Long-term liabilities
1,750
Common stock
1,500
Retained earnings
1,250
Sales
10,000
Operating expenses
9,600
Net income
400
Required:
a.
Calculate profit margin. Discuss its meaning in general and specifically for the result
you calculated.
b.
Calculate asset turnover. Discuss its meaning in general and specifically for the
result you calculated.
Profit Margin
= Net Income ÷ Sales
= $400 ÷ $10,000
= 0.04
was used to cover expenses.
b.
Asset Turnover
= Sales ÷ Total Assets
= $10,000 ÷ ($2,000 + $2,500 + $500)
= 2.00
434 ♦ Chapter 12
16. Financial information for two companies is provided below. Both companies are in the same
industry and compete for customers.
Terrextra
Warping
2008
2007
2008
2007
Net income
$5,250,000
$4,275,000
$9,200,000
$17,100,000
Profit margin
0.12
0.05
0.04
0.09
Asset turnover
1.25
1.5
1.25
1.00
Required:
a.
Calculate return on assets (ROA) for each company for each year.
b.
Compute the change in total assets for each company from 2007 to 2008.
c.
Evaluate the performance of each company by discussing the changes from 2007 to
2008.
Terrextra
Warping
b.
Total Assets = Net Income ÷ ROA
Terrextra
2008: Total Assets = $5,250,000 ÷ 0.15
2007: Total Assets = $4,275,000 ÷ 0.075
Warping
2008: Total Assets = $9,200,000 ÷ 0.05
2007: Total Assets = $17,100,000 ÷ 0.09
efficient, they may be more successful in the long run.
Analysis of Investing Activities ♦ 435
17. The following information is available for 2007 for Cybermed Company :
Sales
$5,000,000
Expenses
2,750,000
Net income
2,250,000
Total assets
3,125,000
Chris, the president of the company, is considering two alternatives to improve performance in
2007.
Alternative 1: An aggressive advertising campaign would increase sales by 20% and increase
expenses 15% with no change in total assets.
Alternative 2: Investment in new plant assets would increase total assets by $1,250,000. Sales
are expected to increase by $750,000, and expenses are expected to increase by $700,000.
Required:
a.
Calculate profit margin, asset turnover, and return on assets for 2007.
b.
Calculate profit margin, asset turnover, and return on assets for each of the two
alternatives.
c.
Which of the two alternatives would you recommend? Why?
a.
Profit Margin = $2,250,000 ÷ $5,000,000 = 0.45
Asset Turnover = $5,000,000 ÷ $3,125,000 = 1.60
b.
Alternative 1:
= ($6,000,000 – $3,162,500) ÷ $6,000,000
= 47.3%
Alternative 2:
increases. For alternative 2, each of these measures decreases.
436 ♦ Chapter 12
18. The following information is available for Jorge Company:
Sales (in millions)
$50
Profit margin
0.4
Asset turnover
1.25
Required:
a.
Calculate return on assets (ROA).
b.
Calculate net income.
c.
Determine the amount of total assets.
19. Atlantis Company reported sales of $50,000 and net income of $10,000. Of the total expenses,
40% represent variable costs. Atlantis has total assets of $4,000.
Required:
a.
Calculate return on assets (ROA) if sales are $50,000.
b.
Calculate net income and return on assets if sales increase 20%.
c.
Calculate net income and return on assets if sales decrease 20%.
d.
Discuss the effect of operating leverage on risk.
a.
ROA = $10,000 ÷ $4,000 = 2.5 or 250%
Net income
Net income
ROA = $3,200 ÷ $4,000 = 0.80 or 80%
Total Assets
= Net Income ÷ ROA
= $20,000,000 ÷ 0.50
= $40,000,000
Analysis of Investing Activities ♦ 437
20. Financial information for two companies is provided below:
Mourning
Byrd
2008
2007
2008
2007
Total assets (in thousands)
$ 20
$ 20
$ 40
$ 40
Profit margin
0.25
0.25
0.30
0.20
Asset turnover
1.80
1.30
1.10
1.05
ROA
0.45
0.325
0.33
0.21
Required:
a.
Calculate sales for each company for each year.
b.
Calculate net income for each company for each year.
c.
Calculate the percent changes in sales, net income, and return on assets for each
company.
d.
Which company seems to have the highest operating leverage? Explain.
Mourning
Byrd
b.
Mourning
Byrd
438 ♦ Chapter 12
21. The following information is available for Halstead Company:
Sales (in millions)
$300
Total assets (in millions)
80
Profit margin
0.15
Required:
a.
Calculate net income.
b.
Calculate asset turnover.
c.
Calculate return on assets.
b.
Asset Turnover = Sales ÷ Total assets = $300,000,000 ÷ $80,000,000 = 3.75
Mourning
% Sales
= ($36,000 – $26,000) ÷ $26,000
= 38.5%
% Net Income
= ($ 9,000 – $ 6,500) ÷ $ 6,500
= 38.5%
Byrd
% Sales
= ($44,000 – $42,000) ÷ $42,000
= 4.76%
% Net Income
= ($13,200 – $ 8,400) ÷ $ 8,400
= 57.14%
% ROA
= (0.33 – 0.21) ÷ 0.21
= 57.14%
Analysis of Investing Activities ♦ 439
ESSAY
1. Suppose one of your classmates observes the following: “Stockholders of a company with good
investment opportunities are better off if the company reinvests cash flows from operating
activities, rather than choosing to pay cash dividends.” Do you agree with this statement? Discuss.
2. Clearly distinguish between the concepts of financial leverage and operating leverage. How does
each type of leverage affect income?
440 ♦ Chapter 12
3. Chris Rodriguez, president of QXCI Co., says to you, “We must carefully consider our investing
activities because they are critical to the success of our company.” Explain what she means by
discussing how investment activities can affect a company’s growth.
4. How are the concepts of return on equity and return on assets similar? How are they different?
Discuss.
5. Your supervisor is evaluating several companies for possible acquisition. She instructs you to
compute the following for each firm:
a.
Depreciation and amortization expense to long-term assets
b.
Cash used in investing activities to long-term assets
Why might your supervisor be interested in these ratios? What information about the companies
would these ratios provide? Why would this information be helpful to your supervisor?
Analysis of Investing Activities ♦ 441
6. You are interviewing the chief executive officer (CEO) of a mid-sized, but well-known and
rapidly growing, corporation. She comments, “The investment decisions we make determine, to a
large extent, the financing and operating activities of this company. Do you know why that is?”
Impress her with your knowledgeable response.
442 ♦ Chapter 12
7. You overhear a discussion in which one party says, “Assets and liabilities should be recorded on
the balance sheet at their fair market values.” Do you agree with this statement? Identify the pros
and cons of this idea.
8. Many financial analysts believe that accountants’ use of the historical cost principle makes
financial statement information less helpful than it could otherwise be. Some would even argue
that it makes financial statements misleading. Explain this point of view. What are these people
referring to?