Question

The annual sales for​ Salco, Inc. were $ 4.58 million last year. The​ firm's end-of-year balance sheet was as​ follows: 

Current_assets $498,000 Liabilities $1,009,500
Net_fixed_assets 1,521,000 Owners'_equity 1,009,500
Total_Assets $2,019,000 Total $2,019,000

Salco's income statement for the year was as​ follows:  

Sales $4,580,000
Less:_Cost_of_goods_sold (3,490,000)
Gross_profit $1,090,000
Less:_Operating_expenses (504,000)
Net_operating_income $586,000
Less:_Interest_expense (96,000)
Earnings_before_taxes $490,000
Less:_Taxes_(35%) (171,500)
Net_income $318,500

a. Calculate​ Salco's total asset​ turnover, operating profit​ margin, and operating return on assets.

b.  Salco plans to renovate one of its plants and the renovation will require an added investment in plant and equipment of $ 1.05 million. The firm will maintain its present debt ratio of 50 percent when financing the new investment and expects sales to remain constant. The operating profit margin will rise to 13.2 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 $ 54 comma 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?

a.  Calculate​ Salco's total asset​ turnover, operating profit​ margin, and operating return on assets. The​ company's total asset turnover is 2.27 times.  ​(Round to two decimal​ places.) The​ company's operating profit margin is 12.79​%. ​(Round to one decimal​ place.) The​ company's operating return on assets is 29.02​%. ​(Round to one decimal​ place.)

b.  Salco plans to renovate one of its plants and the renovation will require an added investment in plant and equipment of $ 1.05 million. The firm will maintain its present debt ratio of 50 percent when financing the new investment and expects sales to remain constant. The operating profit margin will rise to 13.2 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? The​ company's new operating return on assets is ?%. ​(Round to one decimal​ place.)

Answer 1

a) asset turnover = sales/ assets = 4580000/2019000 = 2.27
operating profit margin = op income/sales = 586000/4580000 = 12.79% or 12.8%
operating return on assets = op income/assets = 586000/2019000 = 29.02% or 29.0%

(B)
new assets = 2000000 + 1050000 = 3050000
sales = 4580000 (will remain same)
op margin = 13.2% = op income/sales
so op income = 13.2% * 4580000 = 604560
new operating return on assets = new op income/new assets = 604560/3050000 = 19.82% or 19.8%

(C)
old net income = 318500
new net income = [new op income - new interest] * (1-tax rate)
= [604560 - (96000 + 54000)]*(1-35%)
= 295464

old equity = 1,009,500
new equity = 1009500 + 1050000/2 = 1534500
{half of new loan financed through debt and rest through equity}

old ROE = 318500/1,009,500 = 31.55%
new ROE = 295464/1534500 = 19.26%