Question

In January 2007, the Status Quo Company was formed. Total assets were $528,000, of which $340,000 consisted of depreciable fixed assets. Status Quo uses straight-line depreciation of $34,000 per year, and in 2007 it estimated its fixed assets to have useful lives of 10 years. Aftertax income has been $64,000 per year for each of the last 10 years. Other assets have not changed since 2007. a. Compute return on assets at year-end for 2007, 2009, 2012, 2014, and 2016. (Use $64,000 in the numerator for each year.) (Input your answers as a percent rounded to 2 decimal places.) b. To what do you attribute the phenomenon shown in part a? Annual depreciation charges Increase in market share Increase in current assets c. Now assume income increased by 10 percent each year. What effect would this have on your answers to part a?

Answer 1

a. Return on assets (investment)=Income after taxes/ Total Assets

The return on assets for Status Quo will increase over time as the assets depreciate and the denominator gets smaller due to the depreciation. Depriciable Fixed assets at the beginning of 2007 equal $340,000 with a ten-year life which means the depreciation expense will be $34,000 per year.

Book values at year-end are as follows:

2007 = $306000;

2009 = $238,000;

2012 = $136,000;

2014 = $68,000;

2016 = $0

Return on assets (investment)= Income after taxes/(Current assets + Fixed assets)

Out of total assets of $ 5,28,000, fixed assets are $3,40,000 , so $1,88,000 are current assets.

2007 = $64,000/$494000 = 12.96 %

2009 = $64,000/$426,000 = 15.02%

2012 = $64,000/$324,000 = 19.75%

2014 = $64,000/$256,000 = 25%

2016 = $64,000/$188,000 = 34.04%

b. The increasing return on assets over time is due mainly because the fact that annual depreciation charges reduce the amount of investment. The increasing return is in no way due to operations. The Financial analysts of the entity should be aware of the effect of overall asset age on the return-on-investment ratio and be able to search elsewhere for indications of operating efficiency when ROI is very high or very low.

c. As income rises, return on assets will be higher than in part (a) and would indicate an increase in return partially from more profitable operations.