Question

1. Six Measures of Solvency or Profitability

   The following data were taken from the financial statements of Gates Inc. for the current fiscal year.

   Property, plant, and equipment (net)						$3,200,000
   Liabilities:
   	Current liabilities			$1,000,000
   	Note payable, 6%, due in 15 years			2,000,000
   	Total liabilities					$3,000,000
   Stockholders’ equity:
   	Preferred $10 stock, $100 par (no change during year)					$1,000,000
   	Common stock, $10 par (no change during year)					2,000,000
   Retained earnings:
   	Balance, beginning of year	$1,570,000
   	Net income	930,000
   	Preferred dividends	(100,000)
   	Common dividends	(400,000)
   	Balance, end of year					2,000,000
   Total stockholders’ equity						$5,000,000
   Sales						$18,900,000
   Interest expense						$120,000

   Assuming that long-term investments totaled $3,000,000 throughout the year and that total assets were $7,000,000 at the beginning of the current fiscal year, determine the following. Round to one decimal place.

   a. Ratio of fixed assets to long-term liabilities
   b. Ratio of liabilities to stockholders' equity
   c. Asset turnover
   d. Return on total assets	%
   e. Return on stockholders’ equity	%
   f. Return on common stockholders’ equity	%

   Feedback

   a. Divide property, plant and equipment (net) by long-term liabilities.

   b. Divide total liabilities by total stockholders'equity.

   c. Divide sales by average total assets, excluding long-term investments. Average total assets = (Beginning total assets + Ending total assets) ÷ 2. To find ending total assets, use the accounting equation and substitute ending liabilities + stockholders'equity for the amount.

   d. Divide the sum of net income plus interest expense by average total assets. Average total assets = (Beginning total assets + Ending total assets) ÷ 2. To find ending total assets, use the accounting equation and substitute ending liabilities + stockholders'equity for the amount.

   e. Divide net income by average total stockholders'equity. Average total stockholders'equity = (Beginning total stockholders'equity + Ending total stockholders'equity) ÷ 2.

   f. Divide net income minus preferred dividends by average common stockholders'equity. Common stockholders'equity = Common stock + Retained earnings. Average common stockholders'equity = (Beginning common stockholders'equity + Ending common stockholders'equity) ÷ 2.

Check My Work

Answer 1

Answer

• Workings

A	Total Assets - Beginning	$7,000,000
B	Total Assets - Ending	$8,000,000
C = (A+B)/2	Average Total Assets	$7,500,000

• Requirements

a. Ratio of fixed assets to long-term liabilities	1.07	a. Divide property, plant and equipment (net) by long-term liabilities.
b. Ratio of liabilities to stockholders' equity	0.6	b. Divide total liabilities by total stockholders'equity.
c. Asset turnover	4.2	c. Divide sales by average total assets, excluding long-term investments. Average total assets = (Beginning total assets + Ending total assets) ÷ 2. To find ending total assets, use the accounting equation and substitute ending liabilities + stockholders'equity for the amount.
d. Return on total assets	14.0%	d. Divide the sum of net income plus interest expense by average total assets. Average total assets = (Beginning total assets + Ending total assets) ÷ 2. To find ending total assets, use the accounting equation and substitute ending liabilities + stockholders'equity for the amount.
e. Return on stockholders’ equity	18.6%	e. Divide net income by average total stockholders'equity. Average total stockholders'equity = (Beginning total stockholders'equity + Ending total stockholders'equity) ÷ 2.
f. Return on common stockholders’ equity	20.8%	f. Divide net income minus preferred dividends by average common stockholders'equity. Common stockholders'equity = Common stock + Retained earnings. Average common stockholders'equity = (Beginning common stockholders'equity + Ending common stockholders'equity) ÷ 2