Question

Selected financial data from the June 30 year-end statements of Safford Company are given below: Total assets $ 5,500,000 Long-term debt (11% interest rate) $ 730,000 Total stockholders’ equity $ 2,100,000 Interest paid on long-term debt $ 80,300 Net income $ 410,000 Total assets at the beginning of the year were $5,300,000; total stockholders’ equity was $1,900,000. 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?

Answer 1

Here,

Average total assests

= ($ 5,500,000+ $ 5,300,000)/2

= $ 5,400,000

Average total stockholders’ equity

= ( $ 2,100,000+ $ 1, 900,000)/2

=$ 2,000,000

Net Income = $ 410,000

EBIT = (Net Income +Tax) +Interest =$ 410,000+(410,000*40/60) + $ 80,300 = $ 763,633

1. Return on total assets

= (Net Income/Average total Assets) x 100

= (410,000/5,400,000) x 100

=7.6%

2.Return on equity

= (Net Income/Average total stockholders equity) x 100

= (410,000/2,000,000) x 100

= 2.1%

3.Is financial leverage positive or negative?

= EBIT/(EBIT-Interest)

=$ 763,633/($ 763,633-$ 80,300)

=$ 763,633/ $ 683,333

=1.1

Hence finace Leverage is positive.