Question

Return Ratios and Leverage

The following selected data are taken from the financial statements of Redwood Enterprises:

Sales revenue		$659,000
Cost of goods sold		397,000
Gross profit		$262,000
Selling and administrative expense		100,000
Operating income		$162,000
Interest expense		50,000
Income before tax		$112,000
Income tax expense (40%)		44,800
Net income		$67,200
Accounts payable		$45,000
Accrued liabilities		70,000
Income taxes payable		10,000
Interest payable		25,000
Short-term loans payable		150,000
Total current liabilities		$300,000
Long-term bonds payable		$500,000
Preferred stock, 10%, $100 par		$250,000
Common stock, no par		600,000
Retained earnings		350,000
Total stockholders' equity		$1,200,000
Total liabilities and stockholders' equity		$2,000,000

Required:

1. Compute the following ratios for Redwood Enterprises:

Return on sales

Asset turnover (Assume that total assets at the beginning of the year were $1,600,000.)

Return on assets

Return on common stockholders' equity (Assume that the only changes in stockholders' equity during the year were from the net income for the year and dividends on the preferred stock.)

When computing percentage amounts, carry out calculations to four decimal places, but enter your answers to two decimal places; for example, .17856 rounds to .1786 and would be entered as 17.86.

a. Return on sales		%
b. Asset turnover (round to 2 decimal places)		times
c. Return on assets		%
d. Return on common stockholders' equity		%

2. Comment on Evergreen’s use of leverage. Has it successfully employed leverage?

Answer 1

Answer

1.

a. Return on sales = Net income+interest expenses(net of tax) / Net sales

                               =67200 + (50000-20000) / 659000

                               =14.75%

b. Asset turnover = Net sales / Average total assets

                              = 659000 / 1800000

                              =.37 Times

Avg assets 2000000+1600000 / 2 =1800000

c. Return on assets =Net income + interest exp(net of tax) / avg total assets

                                =67200+30000 / 1800000

                                =5%.

d. Return on common stockholders' equity = Net income - pref dividend / avg common stock holders equity

                                                                     =67200-25000 / 600000

                                                                     =7.03%

(pref dividend 250000*10%= 25000)

2.

If return on assets is less than return on stock holder equity then that means the managment has successfully employed the leveraged.

So, in this case return of common stock holder equity is more than the return on assets so the company has successfully employed the leverage.