Question

The financial statements for Castile Products, Inc., are given below:

Castile Products, Inc. Balance Sheet December 31
Assets
Current assets:
Cash	$	21,000
Accounts receivable, net		230,000
Merchandise inventory		320,000
Prepaid expenses		7,000
Total current assets		578,000
Property and equipment, net		850,000
Total assets	$	1,428,000
Liabilities and Stockholders' Equity
Liabilities:
Current liabilities	$	220,000
Bonds payable, 9%		310,000
Total liabilities		530,000
Stockholders’ equity:
Common stock, $5 per value	$	180,000
Retained earnings		718,000
Total stockholders’ equity		898,000
Total liabilities and stockholders’ equity	$	1,428,000

Castile Products, Inc. Income Statement For the Year Ended December 31
Sales	$	2,250,000
Cost of goods sold		1,210,000
Gross margin		1,040,000
Selling and administrative expenses		590,000
Net operating income		450,000
Interest expense		27,900
Net income before taxes		422,100
Income taxes (30%)		126,630
Net income	$	295,470

Account balances at the beginning of the year were: accounts receivable, $230,000; and inventory, $280,000. All sales were on account. Assets at the beginning of the year totaled $1,060,000, and the stockholders’ equity totaled $675,000.

Required:

Compute the following: (For Requirements 1 to 4, enter your percentage answers rounded to 2 decimal places (i.e., 0.1234 should be entered as 12.34).)

1. Gross margin percentage.

2. Net profit margin percentage.

3. Return on total assets.

4. Return on equity.

5. Was financial leverage positive or negative for the year?

rev: 06_13_2017_QC_CS-91150

Answer 1

Answer -

1. Answer -

Gross margin percentage:

= (Gross margin / Sales) * 100

= ($1040000 / $2250000) * 100

= 46.22%

2. Answer -

Net profit margin percentage:

= (Net income / Sales) * 100

= ($295470 / $2250000) * 100

= 13.132%

3. Answer -

Return on total assets:

Average total assets = (Beginning total assets + Ending total assets) / 2

= ($1060000 + $1428000) / 2

= $1244000

Therefore,

Return on total assets = (Net income / Average total assets) * 100

= ($295470 / $1244000) * 100

= 23.75%

4. Answer -

Return on equity:

Average stockholders equity:

= (Beginning stockholders equity + Ending stockholders equity) / 2

= ($675000 + $898000) / 2

= $786500

Therefore,

Return on equity = (Net income / Average stockholders equity) * 100

= ($295470 / $786500) * 100

= 37.5677%

5. Answer -

Financial leverage was positive for the year.

Here, return on equity 37.5677% is higher than return on assets 23.75%, therefore financial leverage was positive for the year. Return on equity is an earning on equity or investment and return on assets is an interest payment of borrowed funds for purchasing assets.