Question

1. ) Please elaborate what will happen to Net Earnings to Sales and Net Earnings to Total Book Assets when you observe these trends. (a) and (b) are separate unrelated circumstances. (show all work)

1. Sales increased by a total of 30% in the prior three years, while Days of Sales in Inventories increased also by 30% in each of these three years. Costs of Goods Sold to Sales remained constant.
2. Gross property, plant, and equipment increased by a total of 30% during the prior three years. Operating and administrative expense increased relative to sales by 30% in the prior three years. Sales remained constant. Costs of goods sold to sales remained constant.

Answer 1

a)

When Sales increases by 30% in the last 3 years and the Cost of goods sold remain same as from the last 3 years then the Net Earning to sales ratio will reduce.

For example :- Let assume Sale is $ 100 and COST is $ 80

three years ago Net Income to sales ratio = 20/100 = 20%

Now sales increase by 30% but COGS is constant,

New Sales = 130 (100+100*30%). COGS = 104 (80 +80*30%)

New profit = 24

Net Income to sales ratio = 24/130 = 18.46%.

b)

When Gross Property, plant & equipment increases by 30% in the last 3 years and the operative expenses also increase by 30 % and the Cost of goods sold & sales remain remain same as from the last 3 years then the Net Earning to Assets ratio will reduce.

For example :- Let assume Sale was $ 100

COSG was $ 70

Operative expenses was $10

Assets was $ 200 three years ago

Net Income to Assets ratio = 20/200 = 10%

Now Assets increase by 30% and Operating expenses by 30% but COGS & Sales is constant,

New Assets = 260 (200+200*30%),

operative expenses = 13 (10 +10 30%)

New profit = 1008013 = 17

Net Income to sales ratio = 17/260 = 6.53%
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