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Exam 4: Profitability Analysis

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Question 31

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Ramos Company included the following information in its annual report: $\begin{array}{|l|l|l|l|}\hline & 2011 & 2010 & 2009 \\\hline \text { Sales } & \$ 178,400 & \$ 162,500 & \$ 155,500 \\\hline\text { Cost of goods sold } & 115,000 & 102,500 & 100,000 \\\hline\text { Operating expenses } & 50,000 & 50,000 & 45,000 \\\hline\text { Net incoume } & 13,400 & 10,000 & 10,500 \\\hline \end{array}$ - Refer to the information for Ramos Company. In a common size income statement for 2011, the cost of goods sold are expressed as:

A) 130%
B) 115%
C) 64.5%
D) 63.1%

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Question 32

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Which of the following would not be considered a committed fixed cost ( a cost that is incurred regardless of the level of activity during the period) ?

A) depreciation expense
B) amortization expense
C) advertising expense
D) rent expense

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Question 33

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Which factor does not explain differences or changes in ROA?

Return on common shareholders' equity can be disaggregated into profit margin, asset turnover and __________________________________________________.

Discuss how the following three elements of risk help us understand return on assets differs across firms and changes over time: 1. Operating leverage 2. Cyclicality of sales 3. Product life cycle

The return on assets measures operating performance independent of financing while the return on common shareholders' equity considers the cost of debt and preferred stock financing. Describe the relationship between ROA and ROCE in terms of where each dollar of return generated by assets is allocated.

The ___________________________________ of interest expense on net income equals one minus the marginal tax rate times interest expense.

Firms that have either convertible securities or stock options or warrants outstanding have __________________________________________________.

Orca Industries Below are the two most recent balance sheets and most recent income statement for Orca Industries. The company has an effective tax rate of 35%. $\begin{array}{llcc}\text { Balance Sheet }&2011&2010 \\ \text { Assets: } &\\ \text { Cash} &\$10,000&\$6,000\\ \text { Accounts Receivable (net) } &6,000&1,500\\ \text { Inventory } &8,000&10,000\\ \text { Long-lived assets} &12,000&11,000\\ \text { Less: Accumulated depreciation } &\underline{(4,000) }&\underline{(2,000) } \\ \text { Total assets } &\underline{\$32,000}&\underline{\$26,500}\\\\ \text { Liabilities and Stockholders' Equity: } &\\ \text {Accounts payable } &\$5,000&\$6,000\\ \text { Deferred revenues } &1,000&2,000\\ \text { Long-term note payable } &10,000&10,000\\ \text { Less: Discount on note payable} & (800) &(1,000) \\ \text {Common stock } &12,000&6,000\\ \text { Retained earnings} &\underline{4,800}&\underline{\$3,500}\\ \text {Total liabilities and stockholders' equity } &\underline{\$32,000}&\underline{\$26,500}\\\\ \text { Income Statement} &\\ \text { For the year ended December 31, 2011 } &\\ \text { Revenues} &&\$42,000\\ \text { Cost of goods sold } &&(24,000) \\ \text { Depreciation expense} &&(2,000) \\ \text { Interest expense } &&(3,000) \\ \text { Bad debt expense} &&(2,000) \\ \text { Other expense (including income taxes) }& &\underline{(9,000) }\\ \text { Net income } &&\underline{\$2,000}\\\end{array}$ - Refer to the information for Orca Industries. Orca's accounts receivable turnover is (assume that Orca makes all sales on account)

In order to measure how profitable a firm is in generating a return for its common shareholders, a financial analyst would examine the return on _____________________________________________.

The following balance sheets and income statements are for Net Devices Inc., a manufacturer of small electronic devices, including calculators, personal digital assistants and mp3 players. Use the information to calculate the following information: a. Compute the rate of return on assets for Net Devices for both 2011 and 2010. Disaggregate the rate of return on assets into the profit margin on ROA and asset turnover components. The income tax rate is 35%. b. Calculate the accounts receivable turnover ratio for Net Devices for 2011 and 2010. All of the company’s sales were made on account. c. Calculate the inventory turnover ratio for Net Devices for 2011 and 2010. d. Calculate the fixed assets turnover ratio for Net Devices for 2011 and 2010. e. Calculate the rate of return on common shareholders’ equity for Net Devices for 2011 and 2010. The amount of preferred dividends paid each year appear after the income statement. Calculate profit margin for ROCE. f. Determine Net Devices capital structure leverage for 2011 and 2010. g. Calculate Net Devices earnings per share for 2011 and 2010.

Krane, Inc.reported net income (amounts in thousands) of $619,700 for Year 4. The weighted average of common shares outstanding during Year 4 was 468,810 shares. Krane Inc., subtracted interest expense net of tax saving on convertible debt of $4,820. If the convertible debt had been converted into common stock, it would have increased the weighted average common shares outstanding by 20,905 shares. Krane Inc., has outstanding stock options that, if exercised, would increase the weighted average of common shares outstanding by 7,335 shares. REQUIRED: Compute basic and diluted earnings per share for Year 4, showing supporting computations.

Asset turnover represents

Below are three relationships that are important to the determination of profitability. Assume assets were $22,900,000 on Dec. 31, 2008. 1. Operating leverage $=$ $\frac{\text { Earnings before interest but after taxes }}{\text { Average assets. }}$ 2. Financial structure leverage $=$ $\frac{\text { Net income available to common shareholders }}{\text { Earnings before interest but after taxes }}$ 3. $\mathrm { ROCE } = \mathrm { ROA } ^ { \prime }$ Common earnings leverage 'Financial structure leverage REQUIRED: Compute the operating leverage, financial structure leverage, and ROCE (rounded to two places). Then use these relationships to analyze how the profitability of X-Mart changed over the three year period below. What does the company need to do to reverse this trend? What are the risks of your strategy? $\begin{array}{|l|l|l|l|}\hline\text { As of Dec. } 31 & 2009&2010&2011\\\hline \text { ROA } & 0.10 &0.10&0.08\\\hline \text { Assets } & \$ 27,500,000&\$23,000,000&27,600,000 \\\hline \text { Net income available to common shareholders } & \$ 67,250,000 &\$68,960,210&\$70,910,840\\\hline \text { Earrings after taxes but before interest } & \$ 25,000,000&\$24,541,000&\$24,794,000 \\\hline\end{array}$

Sensitron and Douglas Tools manufacture and market power tools and accessories. Sensitron targets customers in the professional contractor market, while Douglas Tools focuses on home users and professionals. Selected financial data for the companies appears below. $\begin{array}{c}\begin{array}{lll}\text {Sensition}\\\text {Sales}\\\text {Average Accounts Receivable}\\\text {Change in Sales from previous year}\\\\\text {Douglas Tools}\\\text {Sales}\\\text {Average Accounts Receivable}\\\text {Change in Sales from previous year} \end{array}\begin{array}{l}\mathbf{2010} \\\$ 2,109,100 \\564,500 \\0.64 \% \\\\\mathbf{2010 }\\\$ 4,394,000 \\718,800 \\3.50 \% \end{array}\begin{array}{l}\mathbf{ 2009}\\\$2,095,700 \\608,650 \\-3.68 \% \\\\\mathbf{2 0 0 9} \\\$ 4,245,600 \\745,850 \\-5.12 \% \end{array}\begin{array}{l}\mathbf{ 2008} \\\$ 2,175,700 \\631,072 \\11.83 \% \\\\\mathbf{2 0 0 8} \\\$ 4,474,900 \\803,150 \\0.59 \% \end{array}\end{array}$ Required: 1. Calculate the accounts receivable turnover ratio for each firm for year 2010, 2009, 2008. 2. Suggest reasons for the differences in the accounts receivable turnover ratios for these two firms.

Return on assets can be disaggregated into profit margin for return on assets and ______________________________.

________________________________________ is the level of earnings and the growth in the levels of earnings expected to persist in the future.

Return on assets can be a misleading ratio when analyzing technology firms because two important assets, ______________________________ and ______________________________ do not appear on their balance sheets

Carl Industries has condensed balance sheets as shown: $\begin{array}{|l|l|l|l|}\hline & 2011 & 2010 & 2009 \\\hline \text { Assets: } & & & \\\hline \text { Curent assets } & \$ 55,000 & \$ 56,500 & \$ 70,000 \\\hline \text { Plant \& equipment net } & 495,000 & 410,000 & 440,000 \\\hline \text { Intangible assets, net } & 20,000 & 27,500 & 40,000 \\\hline \text { Total assets }& \$ 570,000 & \$ 494,000 & \$ 550,000 \\\hline& & & \\\hline \text { Liabilities \& Stckckolders' Equity: } & & & \\\hline \text { Curent liabilities } & \$ 40,000 & \$ 35,000 & \$ 32,500 \\\hline \text { Long term liabilities } & 395,000 & 310,000 & 375,000 \\\hline \text { Stoclcholders' equity } & 135,000 & 149,000 & 142,500 \\\hline\text { Total liabilities \& equity }& \$ 570,000 & \$ 494,000 & \$ 550,000 \\\hline & & &\end{array}$ - Refer to the information for Carl Industries. In a common size balance sheet for 2010, plant and equipment (net) is expressed as

The rationale for adding back the _______________________________________________________ relates to attaining consistency in the numerator and denominator of ROA.