Question

The financial statements for Castile Products, Inc., are given below:

Castile Products, Inc.
Balance Sheet
December 31
  Assets
  Current assets:
     Cash $ 19,000
     Accounts receivable, net 220,000
     Merchandise inventory 330,000
     Prepaid expenses 8,000

  Total current assets 577,000
  Property and equipment, net 850,000

  Total assets $ 1,427,000

  Liabilities and Stockholders' Equity
  Liabilities:
     Current liabilities $ 270,000
     Bonds payable, 12% 390,000

  Total liabilities 660,000
  Stockholders’ equity:
     Common stock, $5 par value $ 140,000
     Retained earnings 627,000

  Total stockholders’ equity 767,000

  Total liabilities and stockholders' equity $ 1,427,000

Castile Products, Inc.
Income Statement
For the Year Ended December 31
  Sales $ 2,250,000
  Cost of goods sold 1,170,000

  Gross margin 1,080,000
  Selling and administrative expenses 570,000

  Net operating income 510,000
  Interest expense 46,800

  Net income before taxes 463,200
  Income taxes (30%) 138,960

  Net income $ 324,240

     Account balances at the beginning of the year were: accounts receivable, $190,000; and inventory, $310,000. All sales were on account. Assets at the beginning of the year totaled $1,050,000, and the stockholders’ equity totaled $645,000.

Required:
Compute the following:

1.

Gross margin percentage. (Round your percentage answer to 2 decimal places (i.e., 0.1234 should be entered as 12.34).)

      

2.

Net profit margin percentage. (Round your answer to the nearest whole percentage place (i.e., 0.1234 should be entered as 12%).)

        

3.

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

       

4.

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

       

5. Was financial leverage positive or negative for the year?

Positive
Negative

Answer 1

(1) – Gross Margin Percentage

Gross Margin = [Gross margin / Sales] x 100

= [$10,80,000 / 22,50,000] x 100

= 48%

(2) – Net Profit Margin Percentage

Profit Margin = [Net Income / Sales] x 100

= [$324,240 / 22,50,000] x 100

= 14%

(3) - Return on Total Assets

Return on Total Assets = Net Income + Interest[1 – tax Rate] / Average Total Assets

= {$324,240 + 46,800[1 - 0.30] } / [ ($14,27,000 + 10,50,000)/2] x 100

= [$357,000 / 12,38,500] x 100

= 28.8%

(4) - Return on Equity

Return on Equity = [Net Income / Average Stockholder’s Equity] x 100

= [ $324,240 / {($767,000 + 645,000)/2] x 100

= [$324,240 / 706,000] x 100

= 45.9%

(5) – POSITIVE. Financial leverage Positive since the Return on Equity [45.9%] is greater than the Return on Total Assets[28.8%]