Question

Evaluate a company's profitability and solvency (LO 4), AP P11-7A Spahn Company manufactures backpacks. During 2017, Spahn issued bonds at 10% interest and used the cash proceeds to purchase treasury stock. The following finan- cial information is available for Spahn Company for the years 2017 and 2016. 2017 2016 Sales revenue Net income Interest expense Tax expense Dividends paid on common stock Dividends paid on preferred stock Total assets (year-end) Average total assets Total liabilities (year-end) Avg. total common stockholders' equity $ 9,000,000 2,240,000 500,000 670,000 890,000 300,000 14,500,000 15,687,500 6,000,000 9,400,000 9,000,000 2,500,000 140,000 750,000 1,026,000 300,000 16,875,000 17,763,000 3,000,000 14,100,000 Instructions (a) Use the information above to calculate the following ratios for both years: (1) return on assets, (2) return on common stockholders' equity, (3) payout ratio (b) Referring to your findings in part (a), discuss the changes in the company's (c) Referring to your findings in part (a), discuss the cha (d) Based on your findings in (b), was the decision to issue debt to purchase common assets ratio, and (5) times interest earned. ity from 2016 to 2017 from 2016 to 2017 stock a wise one? , (4) debt to profitabil- nges in the company's solvency

Answer 1

Requirement-(a Ratios Return on assets Return on common stockholders' equity Payout ratio Debt to assets ratio Times interest earned 2017 2016 Formula Remarks 21.74% 23.83% 0.531 0.41 19.08% (Operating profits / Average total assets) x 100 17.73% (Net income / Average commonstockholders' equity) x 100 0.530 (Common Dividends) + Preferred Dividends) /Net Income) Operating Profit Net Income Interest Expense Tax Expense 0.18 Total liabilities (year-end) /Total assets (year-end) 6.82 times 24.21 times Operating profits/Interest expense Operating Profit Net IncomeInterest ExpenseTax Expense Requirement-(b Return on assets, Return on common stockholders' equity are the profitability ratios. From the results of Requirement-(a), both the ratios have increased siginificantly. That is, Return on assets increased by 2.6% and Return on commonstockholders' equity increased by 6% roughly. It is really impressive and shows company's growth in terms of profitability position. quiremen Payout ratio, Debt to assets ratio and Time interest earned ratio are the solvency ratio. Greater the solvency ratios, greater the company's solvency position. From the results of Requirement-(a), both payout ratio and debt to assets ratio have increased when compared to 2016 but time interest ratio decreased from 24.21 times to 6.82 times. It means that company's ability to meet interest expense commitments have decreased significantly which is not a good sign. From the results of Requirement-(b), the decision to issue debt to purchase common stock was a wise one because return on assets as well as return common stockholders' equity have increased considerably