Question

(Financial statement​ analysis) The annual sales for​ Salco, Inc. were $4.58 million last year.

Current assets	$505,000		Liabilities	$1,009000
Net fixed assets	1,513,000		​Owners' equity	$1,009,000
Total Assets	$2,018,000		Total	$2,018,000

Salco's income statement for the year was as​ follows Sales	$4,580,000
​Less: Cost of goods sold	(3,507,000)
Gross profit	$1,073,000
​Less: Operating expenses	(492,000)
Net operating income	$581,000
​Less: Interest expense	(109,000)
Earnings before taxes	$472,000
​Less: Taxes ​(35%​)	(165,200)
Net income	$306,800

B) Salco plans to renovate one of its plants and the renovation will require an added investment in plant and equipment of $1.06 million. The firm will maintain its present debt ratio o50 percent when financing the new investment and expects sales to remain constant. The operating profit margin will rise to 13.8 percent. What will be the new operating return on assets ratio​ (i.e., net operating income divided by ÷total assets) for Salco after the​ plant's renovation?

C) Given that the plant renovation in part (b​) occurs and​ Salco's interest expense rises by $55,000

per​ year, what will be the return earned on the common​ stockholders' investment? Compare this rate of return with that earned before the renovation. Based on this​ comparison, did the renovation have a favorable effect on the profitability of the​ firm?

Please show your work. Thank you so much!

Answer 1

b)Operating Profit Margin = 13.8%

Operating Profit = 4,580,000*13.8% = $632,040

New operating return on assets ratio = Operating Profit/Total Assets

= 632,040/(2,018,000+1,060,000)

= 20.53%

c)Return on Common Stockholders Investment = Net Income/Common Stockholders Investment

Operating Profit = $632,040

Less: Interest Expense = 164,000

Earnings before taxes = $468,040

Less: Taxes @35% = $163,814

Net Income = $304,226

Return on Common Stockholders Investment = 304,226/(1,009,000+530,000

= 19.77%

Rate of Return before Renovation = 306,800/1009,000

= 30.41%

Since the return reduced, the renovation did not have a favourable effect on the profitability of firm.