Question

Exercise 14-9 Financial Ratios for Assessing Profitability and Managing Debt [LO14-4, LO14-5]

The financial statements for Castile Products, Inc., are given below:

Castile Products, Inc. Balance Sheet December 31
Assets
Current assets:
Cash	$	6,500
Accounts receivable, net		35,000
Merchandise inventory		70,000
Prepaid expenses		3,500
Total current assets		115,000
Property and equipment, net		185,000
Total assets	$	300,000
Liabilities and Stockholders' Equity
Liabilities:
Current liabilities	$	50,000
Bonds payable, 10%		80,000
Total liabilities		130,000
Stockholders’ equity:
Common stock, $5 per value		30,000
Retained earnings		140,000
Total stockholders’ equity		170,000
Total liabilities and stockholders’ equity	$	300,000

Castile Products, Inc. Income Statement For the Year Ended December 31
Sales	$	420,000
Cost of goods sold		292,500
Gross margin		127,500
Selling and administrative expenses		89,500
Net operating income		38,000
Interest expense		8,000
Net income before taxes		30,000
Income taxes (30%)		9,000
Net income	$	21,000

Account balances at the beginning of the year were: accounts receivable, $25,000; and inventory, $60,000. All sales were on account. Assets at the beginning of the year totaled $280,000, and the stockholders’ equity totaled $161,600.

Required:

Compute the following:

1. Gross margin percentage. (Round your percentage answer to 2 decimal places (i.e., 0.1234 should be entered as 12.34).)

2. Net profit margin percentage. (Round your answer to the nearest whole percentage place (i.e., 0.1234 should be entered as 12).)

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

4. Return on equity. (Round your percentage answer to 1 decimal place (i.e., 0.1234 should be entered as 12.3).)

5. Was financial leverage positive or negative for the year?

Answer 1

1. Gross Margin Percentage= Gross Margin/ Sales*100
= $ 127,500/ 420,000*100
= 30.35%

2. Net Profit Margin Percentage= Net Income/ Sales*100
= $ 21,000/ 420,000*100
= 5%

3. Return on total Assets= Net operating Income/ Average Total Assets*100
= $ 38,000 / ((280,000+300,000)/2))*100
= 38000/ 580000*100
= 6.55%

4. Return on Equity= Net Income/ Average Shareholder's Equity*100
= $ 21000/ ((161600+170000)/2))* 100
= 21000/ 165800*100
= 12.66%

5. Financial Levarge= Total Debt/ shareholer's Equity
= $ 130000/ 170000
= 0.76:1
Financial ratio was positive during the year.