Question

1. Profitability Analysis

   Albion Inc. provided the following information for its most recent year of operations. The tax rate is 40%.

   Sales	$100,000
   Cost of goods sold	45,000
   Net income	10,500
   Interest expense	350
   Assets—beginning balance	120,000
   Assets—ending balance	126,000
   Preferred dividends	$300
   Common dividends (paid December 31)	$8,000
   Common shares outstanding—January 1	30,000 shares
   Common shares outstanding—December 31	40,000 shares
   Average common stockholders' equity	$55,000
   Market price per common share	$12

   Required:

   Round all answers to two decimal places except for dividend payout ratio which is rounded to four decimal places.

   1. Compute the following:

   a. Return on sales		%
   b. Return on assets		%
   c. Return on stockholders' equity		%
   d. Earnings per share	$
   e. Price-earnings ratio
   f. Dividend yield		%
   g. Dividend payout ratio

   2. CONCEPTUAL CONNECTION: Assume you are considering an investment to provide retirement income. Based on the above, which would be of particular interest to you?

   Since all the ratios are profitability ratios, they should all be of interest to investors. Some, however, may be of more interest than others depending on the objectives of the potential investor. For an investor looking for an investment to provide retirement income, the dividend yield ratio would be of particular interest.

   Feedback

   1. Return on Sales = Net Income / Sales
   2. Return on Assets = [Net Income / [Interest Expense(1 – Tax Rate)]] / Average Total Assets
   3. Return on Stockholders’ Equity = [Net Income – Preferred Dividends] / Average Stockholders' Equity
   4. Earnings per Share = [Net Income – Preferred Dividends] / Average Common Shares
   5. Price-Earnings Ratio = Market Price per Share / Earning per Share
   6. Dividend Yield = Dividends per Common Share / Market Price per Share
   7. Dividend Payout Ratio = Common Dividends / [Income – Preferred Dividends]

Answer 1

Solution: Operating Income a) Return on Sale: where operating income is Net Income +Interest Expense+ Tax expense Sale 10500+350+(10500) 0.40/0.60 where tax expense is Net income* tax rate/(1-tax rate) 100000 10500+350 7000 100000 17850 100000 0.1785 Or 17.85 % Net income+{Interest Expense(1- Tax rate) b) Return on Assets Average Total Assets where Average Total assets is (120000+126000)/2 10500+(350(1-0.40) 123000 10710 123000 0.08707317073 Or 8.71% Net Income- Preffered Dividend c) Return on stockholders equuity: Average Common Stockholder's equity 10500-300 55000 0.1854545455 Or 18.54% d) Earning Per Share: Net Income- Preferred Dividend Average Common Share 10500- $300 where average common shares are (30000+40000)/2 35000 0.2914285714 Or $ 0.29 per share