Question

Using the income statement for the Sports Car Tire Company, compute the following ratios (show formula + calculations):

a. Interest coverage

b. The fixed charge coverage

The total assets for this company equal $40,000. Set up the formula for the DuPont system ratio analysis, and compare c,d and e.

c. Profit margin

d. Total asset turnover

e. Return on assets (investment)

The Sports Car Tire Company

Sales   $20,000
Less: Cost of goods sold   9,000
Gross profit   11,000
Less: Selling and administrative expense   4,000
Less: Lease expense   1,000
Operating profit*   6,000
Less: Interest expense   500
Earnings before taxes   5,500
Less: Taxes (40%)   2,200
Earnings after taxes   $3,300
*Equals income before interest and taxes.

Answer 1

(a) Interest coverage = Earnings before Interest and Tax / Interest expense

Earnings before Interest and Tax =6000

Interest expense = 500

Interest coverage = 6000 / 500 = 12

(b) The fixed charge coverage = (EBIT+Lease payments) / (Interest payments + Lease payments)

The fixed charge coverage = (6000+1000) / (500+1000) = 4.67

(c) Profit margin = Net Income/ Sales

Net Income = 3,300

Sales = 20,000

Profit margin = 3,300/20000 = 0.165

(d) Total asset turnover = Sales / Average total assets

Sales = 20,000

Average total assets = 40,000

Total asset turnover = 20,000/40,000 = 0.5

(e) Return on assets = Net income/ Total assets

Net income = 3300

Total assets = 40000

Return on assets = 3300/40000 = 0.0825

The DuPont system of analysis breaks down the ROA (Return on assets) into 2 components - Profit margin, Total asset turnover

ROA = Profit margin*Total asset turnover

Here we find that Profit margin*Total asset turnover = 0.165*0.5 = 0.0825

which is equal to the ROA obtained in subpart (e)