Question

#4.

Profit margin

a). Your company had the following balance sheet and income statement information for 2002:

Balance Sheet:

Cash $ 20

A/R 1,000

Inventories 5,000

Total current assets $6,020

Debt $4,000

Net fixed assets 2,980

Equity 5,000

Total assets $9,000

Total claims $9,000

Income Statement:

Sales $10,000

Cost of goods sold 9,200

EBIT $ 800

Interest (10%) 400

EBT $ 400

Taxes (40%) 160

Net income $ 240 \

The industry average inventory turnover is 5. You think you can change your inventory control system so as to cause your turnover to equal the industry average, and this change is expected to have no effect on either sales or cost of goods sold. The cash generated from reducing inventories will be used to buy tax-exempt securities that have a 7 percent rate of return. What will your profit margin be after the change in inventories is reflected in the income statement?

a. 2.1%

b. 2.4%

c. 4.5%

d. 5.3%

e. 6.7%

(The following information applies to the next two problems.)

Miller Technologies recently reported the following balance sheet in its annual report (all numbers are in millions of dollars):

Cash $ 100

Accounts payable $ 300

Accounts receivable 300

Notes payable 500

Inventory 500

Total current liabilities $ 800

Total current assets $ 900

Long-term debt 1,500

Total debt $2,300

Common stock 500

Retained earnings 400

Net fixed assets 2,300

Total common equity $ 900

Total assets $3,200

Total liabilities and equity $3,200

Miller also reported sales revenues of $4.5 billion and a 20 percent ROE for this same year.

ROA

b). What is Miller’s ROA?

a. 2.500%

b. 3.125%

c. 4.625%

d. 5.625%

e. 7.826%

Answer 1

Ans.

a)

Sales = $ 10,000

Current Inventory = $ 5,000

Current inventory turnover = Sales /Inventory = $10,000/ $ 5,000 = 2.

Industry average inventory turnover = 5 (given)

= Sales /Inventory = 5

Inventory = Sales/5 = 10,000/5 = $2,000

Freed cash = $5,000 - $2,000 = $3,000.

Increase in NI = 0.07 * ($3,000) = $210.

New Profit margin = Net Income /Sales = ($240 + $ 210)/$10,000 = $ 450/$ 10,000 = 0.045 or 4.5%

So the correct ans is C. 4.5%

b)

ROA = Net Income/Assets

Total assets = $ 3,200

ROE = 0.2 (given)

Net Income /Common equity = 0.20

Common Equity = $ 900

Net Income /$ 900 = 0.20

Net Income = $ 900 * 0.2 = $ 180

So, ROA = $180/$3,200= 0.05625 or 5.625%.

So correct ans is D. 5.625%