Question

The return on assets of a firm is 25.20%.

(a) If the firm has a profit margin of 7%, its total asset turnover is ___________.

(b) If the firm has a debt-to-total-assets ratio of 50%, the firm’s return on equity is __________.

Consider the following items. For each item determine if it results in an increase or a decrease in cash flow:

(c) Increase in account receivable

(d) Depreciation expense

Answer 1

Ans. A

Total assets turnover = Return on assets / Profit margin

= 25.20% / 7%

= 3.6 times

Ans. B

*Calculation of equity ratio:

Debt to assets ratio is 50% it means that the equity ratio will also be 50% because both of these are calculated on the basis of total assets.

*Calculation of financial leverage:

Financial leverage = Total assets ratio / Equity ratio

= 100% / 50%

= 2 times

*Calculation of Return on equity:

Return on equity = Profit margin * Total assets turnover * Financial leverage

= 7% * 3.6 * 2

= 0.504 or 50.40%

Ans. C

Increase in accounts receivable will result in a decrease in cash inflow because increase in current assets are deducted from net income in the calculation of cash flow from operating activities (indirect method).

Ans. D

Depreciation expense will increase the cash flow because non cash expenses are added to net income under the operating activities section of cash flow statement.