Question

Return Ratios and Leverage

The following selected data are taken from the financial statements of Cedar Industries:

Sales revenue		$654,000
Cost of goods sold		392,000
Gross profit		$262,000
Selling and administrative expense		100,000
Operating income		$162,000
Interest expense		50,000
Income before tax		$112,000
Income tax expense (40%)		44,800
Net income		$67,200
Accounts payable		$45,000
Accrued liabilities		70,000
Income taxes payable		10,000
Interest payable		25,000
Short-term loans payable		150,000
Total current liabilities		$300,000
Long-term bonds payable		$500,000
Preferred stock, 10%, $100 par		$250,000
Common stock, no par		600,000
Retained earnings		350,000
Total stockholders' equity		$1,200,000
Total liabilities and stockholders' equity		$2,000,000

Required:

1. Compute the following ratios for Cedar Industries:

1. Return on sales
2. Asset turnover (Assume that total assets at the beginning of the year were $1,600,000.)
3. Return on assets
4. Return on common stockholders' equity (Assume that the only changes in stockholders' equity during the year were from the net income for the year and dividends on the preferred stock.)

When computing percentage amounts, carry out calculations to four decimal places, but enter your answers to two decimal places; for example, .17856 rounds to .1786 and would be entered as 17.86.

a. Return on sales		%
b. Asset turnover (round to 2 decimal places)		times
c. Return on assets		%
d. Return on common stockholders' equity		%

2. Comment on Evergreen’s use of leverage. Has it successfully employed leverage?
Answer: No, Evergreen has not successfully employed leverage because; the return on the stockholders funds is less than the return to all the providers of capital.

Answer 1

Computation of Return on Sales

Return on Sales=Net Income / Sales

=67200/654000=10.28%

Computation of Return on Asset

Return on Sales=Net Income / Average Asset

=67200/1800000=3.73%

Averahe Asset= ( Beg Asset+ End Asset)/2

=($1600000+2000000)/2= $1800000

Computation of Return on Stock holder equityy

Return on Equity=Net Income / Average Equity

=67200/1167650=5.76%

Averahe Equity= ( Beg Equity+ End Equity)/2

(1135300+1200000)/2=$1167650

Beg Equit= $1200000-67200+2500=1135300

Asset Turover Ratio= Sales/ Average Asset

654000/1800000=0.36 times