Income Statements for Royal, Inc. for the years ended December 31, 20X0 and December 31, 20X1 were as follows (in $ millions):
|
20X0 |
20X1 | |
|
Sales |
78 |
82 |
|
Cost of Goods Sold |
(47) |
(48) |
|
Gross Profit |
31 |
34 |
|
Sales and Administration |
(13) |
(14) |
|
Operating Profit (EBIT) |
18 |
20 |
|
Interest Expense |
(6) |
(10) |
|
Earnings Before Taxes |
12 |
10 |
|
Income Taxes |
(5) |
(4) |
|
Earnings after Taxes |
7 |
6 |
Analysis of these statements for trends in operating profitability reveals that, with respect to Royal’s gross profit margin and net profit margin:
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|
Royal’s gross profit margin (gross profit / sales) was higher in 20X1 (34 / 82 = 41.5%) than in 20X0 (31 / 78 = 39.7%), but net profit margin (earnings after taxes / sales) declined from 7 / 78 = 9.0% in 20X0 to 6 / 82 = 7.3% in 20X1.
Given the following income statement and balance sheet for a company:
Balance Sheet
Assets Year 2006 Year 2007 Cash 200 450 Accounts Receivable 600 660 Inventory 500 550 Total CA 1300 1660 Plant, prop. equip 1000 1580 Total Assets 2600 3240 Liabilities Accounts Payable 500 550 Long term debt 700 1052 Total liabilities 1200 1602 Equity Common Stock 400 538 Retained Earnings 1000 1100 Total Liabilities & Equity 2600 3240 Income Statement
Sales 3000 Cost of Goods Sold (1000) Gross Profit 2000 SG&A 500 Interest Expense 151 EBT 1349 Taxes (30%) 405 Net Income 944
Which of the following is closest to the company's return on equity (ROE)?
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There are several ways to approach this question but the easiest way is to recognize that ROE = NI / average equity thus ROE = 944 / 1,519 = 0.622. If using the traditional DuPont, ROE = (NI / Sales) × (Sales / Assets) × (Assets / Equity): ROE = (944 / 3,000) × (3,000 / 2,920) × (2,920 / 1,519) = 0.622 The 5-part Dupont formula gives the same result: ROE = (net income / EBT)(EBT / EBIT)(EBIT / revenue)(revenue / total assets)(total assets / total equity) Where EBIT = EBT + interest = 1,349 + 151 = 1,500 ROE 2007 = (944 / 1,349)(1,349 / 1,500)(1,500 / 3,000)(3,000 / 2,920)(2,920 / 1,519) = 0.622
Comparative income statements for E Company and G Company for the year ended December 31 show the following (in $ millions):
|
E Company |
G Company | |
|
Sales |
70 |
90 |
|
Cost of Goods Sold |
(30) |
(40) |
|
Gross Profit |
40 |
50 |
|
Sales and Administration |
(5) |
(15) |
|
Depreciation |
(5) |
(10) |
|
Operating Profit |
30 |
25 |
|
Interest Expense |
(20) |
(5) |
|
Earnings Before Taxes |
10 |
20 |
|
Income Taxes |
(4) |
(8) |
|
Earnings after Taxes |
6 |
12 |
The financial risk of E Company, as measured by the interest coverage ratio, is:
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E Company’s interest coverage ratio (EBIT / interest expense) is (30 / 20) = 1.5.
G Company’s interest coverage ratio is (25 / 5) = 5.0. Higher interest coverage means greater ability to cover required interest and lease payments. Note that 1.5 / 5.0 = 0.30, which means the interest coverage for E Company is less than 1/3 that of G Company.
Assume that Q-Tell Incorporated is in the communications industry, which has an average receivables turnover ratio of 16 times. If the Q-Tell’s receivables turnover is less than that of the industry, Q-Tell’s average receivables collection period is most likely:
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Average receivables collection period = 365 / receivables turnover, which is 22.81 days for the industry (= 365 / 16). If Q-Tell’s receivables turnover is less than 16, its average days collection period must be greater that 22.81 days.
Selected financial information gathered from the Matador Corporation follows:
|
|
2007 |
2006 |
2005 |
|
Average debt |
$792,000 |
$800,000 |
$820,000 |
|
Average equity |
$215,000 |
$294,000 |
$364,000 |
|
Return on assets |
5.9% |
6.6% |
7.2% |
|
Quick ratio |
0.3 |
0.5 |
0.6 |
|
Sales |
$1,650,000 |
$1,452,000 |
$1,304,000 |
|
Cost of goods sold |
$1,345,000 |
$1,176,000 |
$1,043,000 |
Using only the data presented, which of the following statements is most correct?
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|
Leverage increased as measured by the debt-to-equity ratio from 2.25 in 2005 to 3.68 in 2007. Gross profit margin declined from 20.0% in 2005 to 18.5% in 2007. Return on equity has improved since 2005. One measure of ROE is ROA × financial leverage. Financial leverage (assets / equity) can be derived by adding 1 to the debt-to-equity ratio. In 2005, ROE was 23.4% [7.2% ROA × (1 + 2.25 debt-to-equity)]. In 2007, ROE was 27.6% [5.9% ROA × (1 + 3.68 debt-to-equity)].
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