Question

Selected financial data from the June 30 year-end statements of Safford Company are given below:

Total assets	$	5,300,000
Long-term debt (10% interest rate)	$	750,000
Total stockholders’ equity	$	2,800,000
Interest paid on long-term debt	$	75,000
Net income	$	460,000

Total assets at the beginning of the year were $5,100,000; total stockholders’ equity was $2,600,000. The company’s tax rate is 30%.

Required:

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

2. Compute the return on equity. (Round your percentage answer to 1 decimal place (i.e., 0.1234 should be entered as 12.3).)

3. Is financial leverage positive or negative?

Answer 1

Given,

Net income (Earnings after tax) : $4,60,000

Earnings before tax (EBT) = $4,60,000/(1- 0.30) [Since given tax rate is 30 percent]

EBT = $6,57,142

Earnings before interest and tax (EBIT) = EBT + Interest

=>$6,57,142 + 75,000    (Given 10 percent interest on Long term debt)

  EBIT = $7,32,142

1. Return on total assets (ROA) :

  ROA = EBIT/ Average total assets

= $7,32142 / $52,00,000 [ Since Avg. total assets is  ($53,00,000 + $51,00,000) / 2 ]

ROA = 14.07

2. Return on equity (ROE) :

ROE = Net income / Average stock holders equity.

= $4,60,000 / $27,00,000 [Since Avg. stock holders equity is ($28,00,000 + $26,00,000) / 2 ]

   ROE = 17.03

3. Financial Leverage is "Positive"

Because both Return on equity (ROE) and Return on assets (ROA) are greater than the interest rate of long term debt.

ROE => 17.03 > 10

ROA => 14.07 > 10

_ _ _ _ x _ _ _ _

ALL THE BEST

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