Question

Profitability Ratios

The following selected data were taken from the financial statements of Vidahill Inc. for December 31, 20Y7, 20Y6, and 20Y5:

December 31

20Y720Y620Y5

Total assets$221,000 $199,000 $177,000

Notes payable (8% interest)70,000 70,000 70,000

Common stock28,000 28,000 28,000

Preferred 5% stock, $100 par14,000 14,000 14,000

(no change during year)      

Retained earnings70,600 53,100 42,000

The 20Y7 net income was $18,200, and the 20Y6 net income was $11,800. No dividends on common stock were declared between 20Y5 and 20Y7. Preferred dividends were declared and paid in full in 20Y6 and 20Y7.

a. Determine the return on total assets, the return on stockholders' equity, and the return on common stockholders’ equity for the years 20Y6 and 20Y7. When required, round to one decimal place.

20Y720Y6

Return on total assets%%

Return on stockholders’ equity%%

Return on common stockholders’ equity%%

b. The profitability ratios indicate that the company's profitability has improved . Since the return on assets is less than  the return on stockholders' equity in both years, there must be positive  leverage from the use of debt.

Answer 1

Average Total assets:
Year-2006 (177000+199000)/2=	188000
Year-2007 (199000+221000)/2=	210000
Total Stockholder equity and average Stockholder equity
			2005	2006	2007
Common Stock		28000	28000	28000
Preferred stock		14000	14000	14000
Retained earnings		42000	53100	70600
Total Stockholder's equity	84000	95100	112600
Average Stockholder's equity:
Year -2006 (95100+84000)/2=	89550
Yer-2007 (95100+112600)/2=	151400
Total Common Stockholder's equity and Average Common Stockholder's equity
			2005	2006	2007
Common Stock		28000	28000	28000
Retained earnings		42000	53100	70600
Total Common Stockholder's equity	70000	81100	98600
Average Common Stockholders:
Year-2006 (70000+81100) /2 =	75550
Year-2007 (81100+98600)/2	89850
Req a.
Return on assets
			2006	2007
Net Icnome		11800	18200
Add: Interest (70000*8%)	5600	5600
Earning before interest	17400	23800
Divide: Average Total assets	188000	210000
Return on total assets	9.26%	11.33%
Req b.
Return on Stockholder's equity
			2006	2007
Net Icnome		11800	18200
Divide: Average Stockholder's equity	89550	151400
Return on stocholder's equity	13.18%	12.02%
Req c.
Return on Common Stockholder's equity
			2006	2007
Net Icnome		11800	18200
Less: Preferred dividend(14000*5%)	700	700
Income available for common st.	11100	17500
Divide: Average common st. equity	75550	89850
Return on Common Stockholder's equity	14.69%	19.48%
Note: Part-b is correctly defined.