Question

The financial statements for Castile Products, Inc., are given below:

Castile Products, Inc. Balance Sheet December 31
Assets
Current assets:
Cash				$	19,000
Accounts receivable, net					230,000
Merchandise inventory					350,000
Prepaid expenses					11,000
Total current assets					610,000
Property and equipment, net					820,000
Total assets				$	1,430,000
Liabilities and Stockholders' Equity
Liabilities:
Current liabilities				$	260,000
Bonds payable, 11%					380,000
Total liabilities					640,000
Stockholders’ equity:
Common stock, $5 par value				$	200,000
Retained earnings					590,000
Total stockholders’ equity					790,000
Total liabilities and stockholders' equity				$	1,430,000

Castile Products, Inc. Income Statement For the Year Ended December 31
Sales	$	2,170,000
Cost of goods sold		1,230,000
Gross margin		940,000
Selling and administrative expenses		560,000
Net operating income		380,000
Interest expense		41,800
Net income before taxes		338,200
Income taxes (30%)		101,460
Net income	$	236,740

Account balances at the beginning of the year were: accounts receivable, $150,000; and inventory, $320,000. All sales were on account. Assets at the beginning of the year totaled $1,050,000, and the stockholders’ equity totaled $645,000.

Required:

Compute the following:

1.	Gross margin percentage. (Round your percentage answer to 2 decimal places (i.e., 0.1234 should be entered as 12.34).)

	Gross margin percentage 45.70 %

      

2.	Net profit margin percentage. (Round your answer to the nearest whole percentage place (i.e., 0.1234 should be entered as 12%).)

	Net profit margin percentage 56 %

       

3.	Return on total assets. (Round your percentage answer to 1 decimal place (i.e., 0.1234 should be entered as 12.3).)

	Return on total assets 87.9 %

      

4.	Return on equity. (Round your percentage answer to 1 decimal place (i.e., 0.1234 should be entered as 12.3).)

	Return on equity 54.1 %

5.	Was financial leverage positive or negative for the year?
	Positive Negative

Answer 1

1. Gross Profit Margin

Gross Profit Margin = (Gross Profit / Sales)*100

                                       = (940000/2170000)*100

                                        = 43.32%

2. Net Profit Margin

Net Profit Margin = (Net Income / Sales)*100

                                    = (236740/2170000)*100

                                    = 11%

3. Return on Total Assets

Return on Total Assets   = (EBIT or Net Operating Income/Average Total Assets)*100

                                                = (380000/1240000)*100

                                                = 30.6%

4. Return on Equity

Return on Equity   = (Net Income/Average Stockholder Equity)*100

                                                = (236740/717500)*100

                                                = 32.9%

5. Financial Leverage

The financial leverage was positive during the year. This can be justified through two statements i.e.

· Positive Net Worth always lead to positive net worth. In our case net worth is $790000.

· When return on equity is higher than interest rate on debt. In our case Return on Equity is 32.9% while interest rate on debt is 11% only.

Note:

Average Total assets and Average stockholder equity is calculated by opening plus closing divided by 2.

Some authors while calculating ROE consider Stockholder equity for relevant financial year rather than average stockholder equity.