Question

Black Co.                                Blue Co.

                                                2017                2016                 2017             2016

Net Income                           $65,000             $60,000           $25,000           $28,000

Income tax expense             18,200             17,000               5,000               5,500

Net sales                          2,500,000          2,300,000           650,000           680,000

Total assets                       500,000             490,000           200,000           210,000

Current assets                          99,000             130,000           120,000           110,000

Operating assets                 470,000             450,000           190,000           190,000

Operating liabilities           175,000             150,000           50,000           56,000

Weighted average shares

            Outstanding                85,000             85,000           75,000           75,000

Current liabilities                 75,000             100,000           75,000           74,000

Total liabilities                   350,000             350,000           100,000           100,000

Stockholder’s equity           150,000             140,000           100,000           110,000

Interest expense                    5,000                 6,000               1,500               1,000

Income before tax                83,200             77,000           30,000           33,500

Cash flow from operations      75,000             110,000           110,000           120,000

Cash paid for investments       74,000             100,000           70,000           60,000

A. Calculate finanacial leverage and spread. Are both companies using leverage effectively? Explain your answer. Assume tax rate of 37%

B. Interpret the ROA verus ROE and EPS for both companies.

C. Compute free cash flow to total debt for both companies.

Answer 1

A.

Particulars	Black co. 2017	Blue co. 2017
Financial leverage
-- ((83200+5000)/83200)	1.06
--(30000+1500)/30000		1.05

B.

Net Income (A)	$    65,000.00	$    25,000.00
Equity (B)	$ 150,000.00	$ 100,000.00
ROE (A/B)	43%	25%
Average assets ©	$ 495,000.00	$ 205,000.00
ROA (A/C)	13%	12%

Weighted average shares o/s (D)	85,000.00	75,000.00
EPS (A/D)	$               0.76	$               0.33

Black co. is performing better compared to blue co. as its ROE and EPS is much higher. than blue co.

C.

Cash flow from operations	$          75,000	$        110,000
Total debt	$        350,000	$        100,000
free cash flow to total debt	0.21	1.10