Question

EXERCISE 8-6 for Rose Corporation's condensed balance sheet for Year 2 is reproduced below: Assets Current assets.................$ 250,000 Noncurrent assets .............. 1.750,000 Total assets .. $2,000,000 Liabilities and Equity Current liabilities.....................$ 200,000 Noncurrent abilities (8% bonds). 675.000 Common stockholders' equity..... 1.125,000 Total liabilities and equity...... $2,000,000 Additional Information 1. Net income for Year 2 is $157,500 2. Income tax rate is 50% 3. Amounts for total assets and shareholders' equity are the same for Years 1 and 2 4. All assets and current liabilities are considered to be operating Required a. Determine whether leverage (from long-term debt) benefits Rose's shareholders. (Mint Bumine ROCE with and without everage b. Compute Rose's NOPAT and RNOA (use ending NOA), c. Denonstrate the favorable effect of leverage Diven the disagregation of ROCE and your answer to part

Johnson Corporation sells primarily two products: (A) consumer cleaners and (B) industrial puri- fiers. Its gross margin and components for the past two years are as follows:

SALES REVENUE. YEAR 7 YEAR 6

ProductA........................ $60,000 $ 35,000

ProductB............... .........$30,000. $ 45,000

Total.................................. 90,000. 80,000

Deduct cost of goods sold

ProductA............... ............50,000 28,000

ProductB............................19,500. 27,000

Total................................... 69,500 55,000

Grossmargin..................... $20,500. 25,000

In Year 6, the selling price of A is $5 per unit, while in Year 7 it is $6 per unit. Product B sells for $50 per unit in both years. Security analysts and the business press expressed surprise at Johnson’s 12.5% increase in sales and $4,500 decrease in gross margin for Year 7.

Required:

Prepare an analysis statement of the change in gross margin for Year 7 versus Year 6. Discuss and show the effects of changes in quantities, prices, costs, and product mix on gross margin.

SORRY WHAT I JUST POST BEFORE IS NOT A CORRECT QUESTION

CONSIDERE THIS ONE

EXERCISE 8-6 Rose Corporation’s condensed balance sheet for Year 2 is reproduced below:

Assets

Currentassets................. $250,000

Noncurrentassets ..........1,750,000

Total assets .................. 2,000,000

Liabilities and Equity

Currentliabilities................................. $200,000

Noncurrent liabilities (8% bonds) ...... 675,000

Common stockholders’ equity. . . . . . 1,125,000

Total liabilities and equity . . . . . . . . 2,000,000

Additional Information:

1. Net income for Year 2 is $157,500.

2. Income tax rate is 50%.

3. Amounts for total assets and shareholders’ equity are the same for Years 1 and 2.

4. All assets and current liabilities are considered to be operating.

Required:

a. Determinewhetherleverage(fromlong-termdebt)benefitsRose’sshareholders.(Hint:ExamineROCEwithand without leverage.)

b. Compute Rose’s NOPAT and RNOA (use ending NOA).

c. DemonstratethefavorableeffectofleveragegiventhedisaggregationofROCEandyouranswertopartb.

Answer 1

Answer Before going through solution dets discuss few points related to this topic. - The financial leverage is the degree to use. its fixed income dents & securities in order to acquire new assets. - It is calculated as the ratio between the total debts and assets - Therefors it & a concept which uses borrowed money in order to increase ito assets as as well as earnings Production etc., is dieu The leverage benefits or not is known by return on capital core shareholder calculation for Formula loverage Rock & net income with leverage 100 common stockholdersequity net Income - $ 157000 with leverage common stock = $1,125,000 orang

The present resent level of debt of rose is calculated as $ 15 7500 Roco a - X 100 $ 1125000 = 0 lux 100 Hence of debt of 14% level is is the the present present return calculateo, calculated for roce. Now the without return of capital employed leverage is as net income without leverage Roce a - X 100 common stockholder equity & non current liabilities + net income without net income with love rage levergo (interest saved - 50% I saved - 50% tax expense & 157500 + ($50,000 - $270vel - 157500 - 270000 IP usoo

Interest saved - $ 675000 x 8 100 2 54000 as non current liabilities & 675000 Interest rate 18%. As the tax expense is 50% in the above data the tax expense will be $270 00 ( 54000 x 50 DE 100 - The return of capital employed wi leverage Roce = $184500 x 100 1125000 + 675000 fromo) $ 18 45oo one X 100 $ 1800000 10.257. the return of capital Therefore 10.25% is employed x bomo with with out leverage 14% leverage 10.25%

Rose NOPAT T = net income with leverago tenon- current liabilities & liabilities & Interest inter exp x le = $ 157500+ [67500 a 87 x (1.50) = $157500 + $ 2700002 $ 18 4 500 NOPAT RNO A = NOPAT Total liabilities – current liabilities I $ lsusoo usoo sunt ($ 2000ooo X 100 $2000.co - 10.25% - RNDA. the As rose is higher than RNOA financial leverage benefits the share holders. lu aran The after cost of debt a 4% und Financial leverago a $ 675000 $ 1,125,000 x 100

= 0. 6x100 = 60% financial leverage. ROCE : RNOA + LEV spread 2 10.25% +0.60 X (10.25% - 40% 147 Now Favourable effect = [0.60 x (10.25% -4%) - 3.75%