Question

​(Related to Checkpoint​ 4.3) ​(Analyzing Profitability) In​ 2016, the Allen Corporation had sales of $68 ​million, total assets of ​$43 million, and total liabilities of $16 million. The interest rate on the​ company's debt is ​5.5 percent, and its tax rate is 35 percent. The operating profit margin is 12 percent.

a. Compute the​ firm's 2016 net operating income and net income.

b. Calculate the​ firm's operating return on assets and return on equity.​ (Hint: You can assume that interest must be paid on all of the​ firm's liabilities.)

Answer 1

Given,

Sales = $68 million or $68000000

Total assets = $43 million or $43000000

Total liabilities = $16 million or $16000000

Interest rate = 5.5%

Tax rate = 35% or 0.35

Operating profit margin = 12%

Solution :-

(a)

Net operating income = Sales x operating profit margin

= $68000000 x 12% = $8160000

Interest expense = Total liabilities x interest rate

= $16000000 x 5.5% = $880000

Net income = (Operating income - interest expense) x (1 - tax rate)

= ($8160000 - $880000) x (1 - 0.35)

= $7280000 x 0.65 = $4732000

(b)

Operating return on assets = Operating income/total assets

= $8160000/$43000000 = 0.1898 or 18.98%

Equity = Total assets - Total liabilities

= $43000000 - $16000000 = $27000000

Return on equity = Net income/equity

= $4732000/$27000000 = 0.1753 or 17.53%