Question

1. Selected financial information for Black Co. and for Blue Co. for 2017 and 2016 follow: Black Co. Blue Co. 2017 2016 2017 2016 Net Income $65,000 $60,000 $25,000 $28,000 Income tax expense 18,200 17,000 5,000 5,500 Net sales 2,500,000 2,300,000 650,000 680,000 Total assets 500,000 490,000 200,000 210,000 Current assets 99,000 130,000 120,000 110,000 Operating assets 470,000 450,000 190,000 190,000 Operating liabilities 175,000 150,000 50,000 56,000 Weighted average shares Outstanding 85,000 85,000 75,000 75,000 Current liabilities 75,000 100,000 100,000 100,000 Total liabilities 350,000 350,000 75,000 74,000 Stockholder’s equity 150,000 140,000 115,000 136,000 Interest expense 5,000 6,000 1,500 1,000 Income before tax 83,200 77,000 30,000 33,500 Cash flow from operations 75,000 110,000 110,000 120,000 Cash paid for investments 74,000 100,000 70,000 60,000 Compute the following for both companies for 2017: a. Return on net operating assets. The effective tax rate for both companies is 37%. b. Net operating profit margin and net operating asset turnover. c. Return on equity. d. Financial leverage (FLEV) and spread. e. Are both companies using leverage effectively? Explain your answer. f. Compute basic earnings per share for both companies. g. Interpret the ROA versus ROE and EPS for both companies. h. Compute the current ratios. i. Compute times interest earned ratios. j. Compute free cash flow to total debt for both companies. k. Which firm would you invest in? Why?

Answer 1

		Black Co.		Blue Co.
		2017	2016	2017	2016
Net Income		65,000	60,000	25,000	28,000
Income Tax Expense	Q	18,200	17,000	5,000	5,500
Net Sales	h	2,500,000	2,300,000	650,000	680,000
Total assets	M	500,000	490,000	200,000	210,000
Current assets		99,000	130,000	120,000	110,000
Operating asset	a	470,000	450,000	190,000	190,000
Operating liabilities	b	175,000	150,000	50,000	56,000
Weighted averae shares o/s	R	85,000	85,000	75,000	75,000
Current liabilities	K	75,000	100,000	100,000	100,000
Total liabilities	L	350,000	350,000	75,000	74,000
Stockholder's equity	i	150,000	140,000	115,000	136,000
Interest expense	c	5,000	6,000	1,500	1,000
Income before tax	d	83,200	77,000	30,000	33,500
Cash flow from operations		75,000	110,000	110,000	120,000
Cash paid for investment		74,000	100,000	70,000	60,000
Solutions
Net Operating asset (g)	a-b	295,000	300,000	140,000	134,000
EBIT (e )	c+d	88,200	83,000	31,500	34,500
EBIT after Tax (f)	(e )*(1-0.37)	55,566	52,290	19,845	21,735
Return on net operating asset	f/g	18.84%	17.43%	14.18%	16.22%
Net operating profit margin	e/h	3.53%	3.61%	4.85%	5.07%
Net operating asset turnover	h/g (Average balance)	8.40		4.74
Profit after tax (j)	D-Q	65,000	60,000	25,000	28,000
Return on equity	j / i	43.33%	42.86%	21.74%	20.59%
Total debt of the company (N)	L-K	275,000	250,000	(25,000)	(26,000)
Total debt + Equity (O)	N+i	425,000	390,000	90,000	110,000
Financial Leverage	N/O	65%	64%	-	-	Blue Co. is debt free company and hence no financial Leverage
Interest expense after tax (P)	(c)*(1-0.37)	3,150	3,780
Net Interest cost for the company	P/N	1.15%	1.51%			The Company is having net interest cost of 1.15% and the return on equity its generating is 43.33%. This shows the company is utilising its debt effectively, However the ROE of Blue Co. is lower and there is no debt, which symbolises blue co. should avail certain debt and increase their ROE.
Basic EPS	J/R	0.76	0.71	0.33	0.37
Return on Asset (ROA)	E/M	17.64%	16.94%	15.75%	16.43%
The return on Asset for Black co. is 17.64% whereas return on equity is 43.33% which is basically because the company is availing cheaper debt and generating return for company's shareholders. Whereas for Blue co. ROA is more than ROE which symbolises the company should avail some debt and generate return like Black Co.