Question

Selected financial data from the June 30 year-end statements of Safford Company are given below:

Total assets	$	3,600,000
Long-term debt (12% interest rate)	$	500,000
Total stockholders’ equity	$	2,400,000
Interest paid on long-term debt	$	60,000
Net income	$	280,000

Total assets at the beginning of the year were $3,000,000; total stockholders’ equity was $2,200,000. The company’s tax rate is 30%.

Required:

1. Compute the return on total assets. (Round your percentage answer to 1 decimal place (i.e., 0.1234 should be entered as 12.3).)

2. Compute the return on equity. (Round your percentage answer to 1 decimal place (i.e., 0.1234 should be entered as 12.3).)

3. Is financial leverage positive or negative?

	1. Return on total assets % 2. Return on equity % 3. Financial Leverage

Answer 1

Stafford Company

	Ratio	Formula	Calculations
1	Return on Total assets	Net income/ Average total assets	280,000/(36,00,000+30,00,000) = 280,000/33,00,000	8.5%
2	Return on Equity	Net income/ Average shareholders equity	280,000/(24,00,000+22,00,000) = 280,000/23,00,000	12.2%
3	Financial leverage			Is Positive*

*Because after tax rate of return on shareholders equity is higher than the cost of debt(even after tax cost of debt). It is a situation where financial leverage is positive.

After tax cost of debt is 8.4% (12×(1-0.3)), tax rate is 30%