Question

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

Total assets	$	5,800,000
Long-term debt (11% interest rate)	$	670,000
Total stockholders’ equity	$	2,200,000
Interest paid on long-term debt	$	73,700
Net income	$	410,000

Total assets at the beginning of the year were $5,600,000; total stockholders’ equity was $2,000,000. The company’s tax rate is 40%.

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?

1.	Return on total assets	0.1	%
2.	Return on equity		%
3.	Financial Leverage

Answer 1

1. Return on Total Assets = EBIT ÷ Average Total Assets

EBIT = NET INCOME + INTEREST = 410000+73700 = 483700

Average Total Assets = (5800000+5600000)/2 = 5700000

Return on Total Assets = 483700 ÷ 5700000 = 0.0849 or 8.49%

2. Return on Equity = Net Income ÷ Stockholders Equity

ROE = 410000÷2200000 = 0.1864 or 18.64%

3. Financial Leverage = Total Debt ÷ Stockholders Equity

Total Debt = Total Assets - Stockholders Equity = 5800000-2200000 = 3600000

Financial Leverage = 3600000÷2200000 = 1.64

There is Negative Leverage beacuse Borrowing Rate is 11% and Return on investment is lower than this 8.49%