Question

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Exercises 817 -10-19 (L041 Comparison of Alternative forms of Financing) Shown below is the liabilities and stockholders' equity Section of the balance sheet for Jana Kingston Company and Mary Ann Benson Company. Each has assets totaling $4,200,000. Jana Kingston Co. Mary Ann Benson Co. Current liabilities $ 300,000 Current liabilities $ 600,000 Long-term debt, 10% 1,200,000 Common stock ($20 par) 2,900,000 - 0.000 Common stock ($20 par) 2,000,000 Retained earnings (Cash Retained earnings (Cash dividends, $328,000) 700,000 dividends, $220,000) 700,000 $4,200,000 S4,200,000 For the year, each company has earned the same income before interest and taxes. Income before interest and taxes Interest expense Mary Ann Benson Co. $1,200,000 Jana Kingston Co. $1,200,000 120,000 1,080,000 486,000 $ 594,000 Income taxes (45%) Net income 1,200,000 540,000 $ 660,000 At year end, the market price of Kingston's stock was $101 per share, and Benson's was $63.50. Instructions (a) Which company is more profitable in terms of return on total assets? (b) Which company is more profitable in terms of return on common stockholders' equity? (c) Which company has the greater net income per share of stock? Neither company issued or reacquired shares during the (d) From the point of view of net income, is it advantageous to the stockholders of Jana Kingston Co. to have the long- debt outstanding? Why? (e) What is the book value per share for each company?

Answer 1

1) Return on total assets: Net income before interest but after taxes / / Total assets

Benson Company: 660,000 / 4,200,000 = 15.71%

Kingston Company: [594,000 + 120,000 - 54,000] / 4,200,000 = 15.71%

2) Return on common stock equity: Net income / Common stock

Kingston Company: 594,000 / 2,700,000 = 22%

Benson Company: 660,000 / 3,600,000 = 18.33%

Kingston Company is the more profitable

3) Net income per share of stock: Net income /

Kingston Company: 594,000 / (2,000,000 / 20) = 594,000 / 100,000 = $5.94

Benson Company: 660,000 / (2,900,000 / 20) = 660,000 / 145,000 = $4.55

Kingston Company has greater net income per share of stock

4) From the point of view of income it would be beneficial for the Kingston Company stockholders to own long-term debt outstanding. The assets received from incurrence of such debt are getting a higher return compared to the cost to the Kingston Company

5) Benson Company: (2,900,000 + 700,000) / 145,000 = $24.83

Kingston Company: (2,000,000 + 700,000) / 100,000 = $27