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Chapter 03: Financial Analysis
3-11
Haines Corp.
2009 2010
a.
Cost of goods sold $1,500,000 $1,875,000
60.0% 62.5%
Sales 2,500,000 3,000,000
==
It is decreasing profitability.
b.
Selling & admin. expense $205,000 $210,000
8.2% 7.0%
Sales 2,500,000 3,000,000
==
It is increasing profitability.
c.
Interest expense $40,000 $45,000
1.6% 1.5%
Sales 2,500,000 3,000,000
==
It is increasing profitability.
8. Profitability ratios (L02) Neon Light Company has $1,000,000 in assets and $600,000 of
debt. It reports net income of $100,000.
a. What is the return on the assets?
b. What is the return on the stockholders’ equity?
c. If the firm has an asset turnover ratio of 3 times, what is the profit margin (return on
sales)?
3-8. Solution: Neon Light Company
a.
Net income
Return on assets (investment) Total assets
$100,000 10%
$1,000,000
=
=
Chapter 03: Financial Analysis
b.
Net income
Return on equity Stockholders' equity
Stockholders' equity total assets total debt
$1,000,000 $600,000 $400,000
Net income $100,000 25%
Stockholders' equity $400,000
OR
Return on
Return on equity
=
=−
= − =
==
= assets (investment)
(1 Debt/Assets)
$600,000
Debt/Assets 60%
$1,000,000
10% 10%
Return on equity 25%
(1 .60) .40
−
==
==
−
3-8. (Continued)
Net income $100,000
Profit margin 3.3%
Sales $3,000,000
= = =
Chapter 03: Financial Analysis
9. Profitability ratios (LO2) Network Communications has total assets of $1,400,000 and
current assets of $600,000. It turns over its fixed assets 4 times a year. It has $300,000 of
debt. Its return on sales is 5 percent. What is its return on stockholders’ equity?
3-9. Solution:
Network Communications
total assets $1,400,000
– current assets 600,000
Fixed assets $ 800,000
Sales Fixed assets Fixed asset turnover
$3,200,000 $800,000 4
=
=
total assets $1,400,000
– debt 300,000
Stockholders’ equity $1,100,000
Net income = Sales profit margin
= $3,200,000 5% = $160,000
Net income
Return on stockholders' equity Stockholders' equity
$160,000 14.55%
$1,100,000
=
==
Chapter 03: Financial Analysis
3-14
10. Profitability ratios (LO2) Fondren Machine Tools has total assets of $3,000,000 and
current assets of $800,000. It turns over its fixed assets 2.6 times per year. Its return on
sales is 6.5 percent. It has $1,200,000 of debt. What is its return of stockholders’ equity?
3-10. Solution:
Fondren Machine Tools
Total assets $3,000,000
– Current assets 800,000
Fixed assets $2,200,000
Sales Fixed assets Fixed asset turnover
$5,720,000 $2,200,000 2.6
=
=
Net income = Sales profit margin
$5,720,000 6.5% = $371,800
Total assets $3,000,000
–Debt 1,200,000
Stockholders’ equity $1,800,000
Net income
Return on stockholders' equity Stockholders' equity
$371,800 20.66%
$1,800,000
=
==
11. a. Profitability ratios (LO2) Alpha Industries had an asset turnover of 1.4 times per
year. If the return on total assets (investment) was 8.4 percent, what was Alpha’s profit
margin?
b. The following year, on the same level of assets, Alpha’s assets turnover declined to 1.2
times and its profit margin was 7 percent.
How did the return on total assets change from that of the previous year?
Chapter 03: Financial Analysis
3-15
3-11. Solution:
Alpha Industries
a. Total asset turnover × Profit Margin = Return on Total assets
8.4%
Profit margin = 6.0%
1.4 =
12. Du Pont system of analysis (LO3) AllState Trucking Co. has the following ratios
compared to its industry for 2010.
AllState
Trucking
Industry
Return on sales………..
3%
8%
Return on assets………
15%
10%
Explain why the return-on-assets ratio is so much more favorable than the return-on-sales
ratio compared to the industry. No numbers are necessary; a one-sentence answer is all that
is required.
3-12. Solution:
Allstate Trucking Company
Allstate Trucking Company has a higher asset turnover ratio than
the industry.
Chapter 03: Financial Analysis
3-16
Return on Assets =Asset Turnover
Return on Sales
15% 10%
vs
3% 8%
Allstate’s Turnover 5×vs 1.25×Industry Turnover
13. Du Pont system of analysis (LO3) Front Beam Lighting Company has the following
ratios compared to its industry for 2010.
Front Beam
Lighting
Industry
Return on assets……………
12%
5%
Return on equity……………
16%
20%
Explain why the return-on-equity ratio is so much less favorable than the return-on-assets
ratio compared to the industry. No numbers are necessary; a one-sentence answer is all
that is required.
3-13. Solution:
Front Beam Lighting Company
Chapter 03: Financial Analysis
14. Du Pont system of analysis (LO3) The King Card Company has a return-on-assets
(investment) ratio of 12 percent.
a. If the debt-to-total-assets ratio is 40 percent, what is the return on equity?
b. If the firm had no debt, what would the return-on-equity ratio be?
3-14. Solution:
King Card Company
a.
Return on assets (investment)
Return on equity (1 Debt/Assets)
12%
(1 0.40)
12%
0.60
20%
=
−
=
−
=
=
15. Du Pont system of analysis (LO3) Using the Du Pont method, evaluate the effects of the
following relationships for the Lollar Corporation.
a. Lollar Corporation has a profit margin of 5 percent and its return on assets
(investment) is 13.5 percent. What is its assets turnover ratio?
b. If the Lollar Corporation has a debt-to-total-assets ratio of 60 percent, what would the
firm’s return on equity be?
c. What would happen to return on equity if the debt-to-total-assets ratio decreased to 40
percent?
3-15. Solution
Chapter 03: Financial Analysis
Lollar Corporation
a.
Profit margin Total asset turnover Return on Investment
5% ? 13.5%
13.5%
Total asset turnover 2.7x
5%
=
=
=
=
b.
Return on assets (investment)
Return on equity (1 Debt/Assets)
13.5%
Existing return on equity (1 0.60)
13.5%
0.40
33.75%
=
−
=
−
=
=
3-15. (Continued)
c.
Return on assets (investment)
Return on equity (1 Debt/Assets)
13.5%
(1 .40)
13.5%
0.60
22.50%
=
−
=
−
=
=
Chapter 03: Financial Analysis
16. Du Pont system of analysis (LO3) Jerry Rice and Grain Stores has $4,000,000 in yearly
sales. The firm earns 3.5 percent on each dollar of sales and turns over its assets 2.5 times
per year. It has $100,000 in current liabilities and $300,000 in long-term liabilities.
a. What is its return on stockholders’ equity?
b. If the asset base remains the same as computed in part a, but total asset turnover goes
up to 3, what will be the new return on stockholders’ equity? Assume that the profit
margin stays the same as do current and long-term liabilities.
3-16. Solution:
Jerry Rice and Grain Stores
a.
Net income Sales profit margin
$4,000,000 3.5%
$140,000
Stockholders' equity Total assets Total liabilities
Total assets Sales/Total asset turnover
$4,000,000/2.5
$1,600,000
Total liabilities Current lia
=
=
=
=−
=
=
=
=bilities Long term liabilities
$100,000 $300,000
$400,000
+−
=+
=
Stockholders' equity $1,600,000 $400,000 $1,200,000= − =
Net income
Return on stockholders' equity Stockholders' equity
$140,000 11.67%
$1,200,000
=
==
Chapter 03: Financial Analysis
3-16. (Continued)
b. The new level of sales will be:
Sales Total assets Total asset turnover
$1,600,000 3
$4,800,000
=
=
=
Net income Sales Profit margin
$4,800,000 3.5%
$168,000
=
=
=
Net income
Return on stockholders' equity Stockholders' equity
$168,000 14%
$1,200,000
=
==
17. Interpreting results from the Du Pont system of analysis (LO3) Assume the following
data for Cable Corporation and Multi-Media, Inc.
Cable Mu1ti
Corporation Media, Inc.
Net income ............................... $ 30,000 $ 100,000
Sales ........................................ 300,000 2,000,000
Total assets .............................. 400,000 900,000
Total debt ................................. 150,000 450,000
Stockholders’ equity................. 250,000 450,000
a. Compute return on stockholders’ equity for both firms using ratio 3a. Which firm has
the higher return?
b. Compute the following additional ratios for both firms.
Net income/Sales
Net income/Total assets
Sales/Total assets
Debt/Total assets
c. Discuss the factors from part b that added or detracted from one firm having a higher
return on stockholders’ equity than the other firm as computed in Part a.
