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The annual sales for Salco, Inc. were $4.57 million last year. The firm's end-of-year balance sheet...

The annual sales for Salco, Inc. were $4.57 million last year. The firm's end-of-year balance sheet was as follows:

Current assets

$509,000

Liabilities

$997,000

Net fixed assets

1,485,000

Owners' equity

997,000

Total Assets

$1,994,000

Total

$1,994,000

Salco's income statement for the year was as follows:

Sales

$4,570,000

Less: Cost of goods sold

(3,492,000)

Gross profit

$1,078,000

Less: Operating expenses

\(503,000)

Net operating income

$575,000

Less: Interest expense

(97,000)

Earnings before taxes

$478,000

Less: Taxes

(35%)

(167,300)

Net income

$310,700

a. Calculate Salco's total asset turnover, operating profit margin, and operating return on assets. b. Salco plans to renovate one of its plants and the renovation will require an added investment in plant and equipment of $1.03 million. The firm will maintain its present debt ratio of 50 percent when financing the new investment and expects sales to remain constant. The operating profit margin will rise to 13.5 percent. What will be the new operating return on assets ratio (i.e., net operating income divided by ÷total assets) for Salco after the plant's renovation? c. Given that the plant renovation in part (b ) occurs and Salco's interest expense rises by $52,000 per year, what will be the return earned on the common stockholders' investment? Compare this rate of return with that earned before the renovation. Based on this comparison, did the renovation have a favorable effect on the profitability of the firm?

Expert Solution

total asset turnover	sales/total of assets	4570000/1994000	2.29
operating profit margin	operating profit/sales	575000/4570000	12.58%
operating return on assets	operating profit/sales	575000/1994000	28.84%

New operating profit margin	575000*(1.135)	652625
operating return on assets	652625/3024000	21.58%
new level of total assets after renovation	1994000+1030000	3024000

		before renovation		after renovation
Operating profit		575000		652625
less interest expense		97000		149000
profit before tax		478000		503625
les tax-35%		167300		176268.8
net income		310700		327356.3
total of equity		997000		1512000
ROE = net income/total of equity		31.16%		21.65%
total of equity = total assets-total of liabilities		997000	997000+(1030000/2)	1512000
No this renovation does not results in favorable effect on profitability of the company

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