Question

The following information is available for the Memphis and Billings companies: Memphis Billings Sales $ 1,500,000 $ 1,500,000 Cost of goods sold 1,050,000 1,125,000 Operating expenses 350,000 250,000 Total assets 1,800,000 1,800,000 Stockholders’ equity 720,000 720,000 Required a. Prepare a common size income statement for each company. b. Compute the return on assets and return on equity for each company. c. Which company is more profitable from the stockholders’ perspective? d. One company is a high-end retailer, and the other operates a discount store. Which is the discounter?

Answer 1

Requirement (a) - Common Size Income Statement for each company

Memphis and Billings Company
Common size income statement
	Memphis ($)	%	Billing ($)	%
Sales	15,00,000	100.0	15,00,000	100.0
Cost of goods sold	10,50,000	70.0	11,25,000	75.0
Gross Profit	4,50,000	30.0	3,75,000	25.0
Operating Expenses	3,50,000	23.3	2,50,000	16.7
Net Income	1,00,000	6.7	1,25,000	8.3

Requirement (b) - Return on assets and return on equity

Return on asset (ROA)

Return on asset (ROA) = [Net Income / Total Assets] x 100

Memphis (ROA) = 5.6% [$100,000 / 18,00,000] x 100

Billing (ROA) = 6.9% [$125,000 / 18,00,000] x 100

Return on Equity (ROE)

Return on Equity (ROE) = [Net Income / Stockholders’ equity] x 100

Memphis (ROE) = 13.9% [$100,000 / 720,000] x 100

Billing (ROE) = 17.4% [$125,000 / 720,000] x 100

Requirement (c)

Billing Company is more profitable from the stockholders’ perspective, since it has the higher Return on Equity of 17.4% as compared to Memphis Company

Requirement (d) – Memphis Company is the discounter, Since it has the lower Net Profit Margin of 6.7%