Question

Profitability Ratios

The following selected data were taken from the financial statements of Vidahill Inc. for December 31, 20Y7, 20Y6, and 20Y5:

		December 31
		20Y7		20Y6		20Y5
Total assets		$172,000		$155,000		$138,000
Notes payable (8% interest)		60,000		60,000		60,000
Common stock		24,000		24,000		24,000
Preferred 7% stock, $100 par		12,000		12,000		12,000
	(no change during year)
Retained earnings		73,725		51,135		36,000

The 20Y7 net income was $23,430, and the 20Y6 net income was $15,975. No dividends on common stock were declared between 20Y5 and 20Y7. Preferred dividends were declared and paid in full in 20Y6 and 20Y7.

a. Determine the return on total assets, the return on stockholders' equity, and the return on common stockholders’ equity for the years 20Y6 and 20Y7. Round percentages to one decimal place.

	20Y7		20Y6
Return on total assets		%		%
Return on stockholders’ equity		%		%
Return on common stockholders’ equity		%		%

b. The profitability ratios indicate that the company's profitability has  . Since the rate of return on total assets is  the return on stockholders' equity in both years, there must be   leverage from the use of debt.

Answer 1

	20y7	20y6
Return on total assets = EBIT/ Average Total Assets
EBIT = NI + Interest + Tax
Net Income	$23,430.00	$15,975.00
Average Assets	$1,63,500.00	$1,46,500.00
Interest = $60000 x 8%	$4,800.00	$4,800.00
ROTA = NI + interest/ Average Total Assets	17.27%	14.18%
Return on stockholders’ equity = Net Income/ Av. shareholder equity
Net Income	$23,430.00	$15,975.00
Shareholder Equity = Share Capital + Retained Earnings + preferred capital	$1,09,725.00	$87,135.00
Average Shareholder equity	$98,430.00	$79,567.50
Return on stockholders’ equity = Net Income/ Av. shareholder equity	23.80%	20.08%
Return on common stockholders’ equity = NI - Preferred Dividend/Av. common stock holders equity
Net Income	$23,430.00	$15,975.00
Preferred Dividend (12,000 x 7%)	$840.00	$840.00
Common stockholder equity = Common stock + Retained Earning	$97,725.00	$75,135.00
Av. Common stockholder equity	$86,430.00	$67,567.50
Return on common stockholders’ equity = NI - Preferred Dividend/Av. common stock holders equity	26.14%	22.40%