Question

Correctly answer each part of the question 5

Profitability ratios help in the analysis of the combined impact of liquidity ratios, asset management ratios, and debt management ratios on the operating performance of a firm. Your boss has asked you to calculate the profitability ratios of Spandust Industries Inc. and make comments on its second-year performance as compared to its first-year performance. The following shows Spandust Industries Inc.'s income statement for the last two years. The company had assets of $8,225 million in the first year and $13,157 million in the second year. Common equity was equal to $4,375 million in the first year, and the company distributed 100% of its earnings out as dividends during the first and the second years. In addition, the firm did not issue new stock during either year Spandust Industries Inc. Income Statement For the Year Ending on December 31 (Millions of dollars) Year 2 Year 1 4,445 3,500 1,610 1,495 140 1,832 1,635 2,613 1,865 242 2,2601,623 649 974 Net Sales Operating costs except depreciation and amortization Depreciation and amortization Total Operating Costs Operating Income (or EBIT) Less: Interest Earnings before taxes (EBT) Less: Taxes (40%) Net Income 353 904 1,356

Answer 1

Answers to the table where empty cells are mentioned:

Units in mn $ unless % or ratio is mentioned

Operating margin --> year 2--> = operating income / net sales = 2613/4445=58.78%

Profit margin --> year 1--> = net income / net sales = 974/3500=27.83%

Return on total assets --> year 2--> = net income / assets = 1356/13157=10.31%

Return on common equity --> year 2--> = net income / common equity = 1356/4375= 30.99%; (Common equity year 2 = common equity year 1 + retained earnings + new stock issue; Common equity year 2 = 4375 + 0+0)

Basic earnings power --> year 1--> = EBIT / assets= 1623/8225=19.73%

Answer to True/false

Statement 1: True - Profit margin = net income / net sales; so 10% means 0.1$ is profit for every 1$ sale

Statement 2: False - Return on total assets = net income / assets; increase in return on asset means either increase in net income or decrease in assets or both

Statement 3: True - Net margin = Operating income - interest - taxes; operating margin = operating income / net sales;

So if net margin falls despite increased operating margin, then it means interest and/or taxes are increasing

Statement 4: False - Return on common equity = net income / common equity; if company issues new shares, denominator goes up and return on common equity goes down