Question

Use the information given below for The Palm Limited to calculate the following ratios for 2019 and give a brief explanation why these ratios will be used interpret and evaluate a company:

1.         Rate of return on total assets

2.         Rate of return on ordinary shareholders' equity

3.         Rate of return on net sales

4.         Times-interest-earned ratio

5.         Debt ratio, 31 December 2019

6.         Current ratio, 31 December 2019

7.         Earnings per ordinary share      

The following information has been taken from the financial statements of The Palm Limited: (The Palm Limited has only issued common shares)

Net profit          Total assets, 1 January 2019 Total liabilities, 31 December 2019      Net sales          Interest expense          Current assets, 31 December 2019    Current liabilities, 31 December 2019 Income tax expense    Total assets, 31 December 2019        Shareholders' equity, 1 January 2019             Shareholders' equity, 31 December 2019 Ordinary shares issued for 2019

$ 60,000 500,000 175,000 900,000 20,000 175,000 75,000 25,000 575,000 300,000 400,000 100,000

Answer:

Ratio	Explanation
1.
2.
3.
4.
5.
6.
7.

Answer 1

SI No.	Ratios	Explanation
1	Return on Total Assets	11.16%	It indicates that the company earns approx. $11 for every $100 asset held.
			It represents the yielding capacity of the assets of the company.
2	Return on Equity	17.14%	It indicates that the company earns approx. $17 for every $100 shares held.
			It represents the yield by holding the shares of the company.
3	Return on Sales	6.67%	It indicates that the company earns approx. $7 for every $100 shares held.
			It represents the Net profit ratio of the company.
4	Times-Interest-Earned Ratio	5.25	It represents the amount spend by the company to service its debt.
			A higher ratio is problematic; however the ratio is lower here
5	Debt Ratio	0.30	It indicates the proportion of the assets held that are financed by debt
			Here, it means that equity finances 70% of the assets.
6	Current Ratio	2.33	It indicates the working capital liquidity of the company. Here, current
			assets are higher than current liabilities and hence, the company is safe.
7	Earnings per Share	15%	It indicates the earnings of shareholders for every shares held by them.

1.Rate of Return on total assets
Rate of return on total assets =	Return
	Average Total assets
Assets as on 1st January 2019	500,000
Assets as on 31st December 2019	575,000
Average Total assets (500,000+575,000)/2	537,500
Return = Net Profit	60,000
Rate of return on total assets (60,000/537,500)	11.16%
2.Rate of return on ordinary shareholders equity
Rate of return on ordinary shareholders equity =	Return
	Shareholders equity
Equity as on 1st January 2019	300,000
Equity as on 31st December 2019	400,000
Average Shareholders equity	350,000
Return = Net Profit	60,000
Return on Equity (60,000/350,000)	17.14%
3.Rate of return on net sales
Rate of return on net sales =	Return
	Net sales
Return = Net Profit	60,000
Net sales	900,000
Rate of return on net sales (60,000/900,000)	6.67%
4.Times interest earned ratio
Times interest earned ratio =	PBIT
	Interest
Profit after tax (Net Profit)	60,000
Add: Tax	25,000
Add: Interest	20,000
PBIT or Profit before interest and tax	105,000
Interest	20,000
Times interest earned ratio (105,000/20,000)	5.25
5.Debt Ratio
Debt Ratio =	Total Liabilities
	Total Assets
Total liabilities (External liabilities)	175,000
Total Assets	575,000
Debt Ratio	0.30
6.Current ratio
Current ratio =	Current Assets
	Current liabilities
Current Assets	175,000
Current liabilities	75,000
Current ratio (175,000/75,000)	2.33
7.Earnings per ordinary share
Earnings per ordinary share =	Earnings
	Number of shares outstanding
Earnings = Net Profit	60,000
Number of shares outstanding as on December 31	400,000
Earnings per ordinary share (60,000/400,000)	15%