Why is there a positive leverage from use of debt? How can we tell that?
Chapter1: Financial Statements And Business Decisions
Section: Chapter Questions
Problem 1Q
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Why is there a positive leverage from use of debt? How can we tell that?
![Dec. 31, Year 3
Dec. 31, Year 2
Dec. 31, Year 1
Total assets
$3,000,000
$2,700,000
$2,400,000
Notes payable (10% interest)
1,000,000
1,000,000
1,000,000
Common stock
400,000
400,000
400,000
Preferred $6 stock, $100 par
200,000
200,000
200,000
Retained earnings
1,126,000
896,000
600,000
The Year 3 net income was $242,000 and the Year 2 net income was $308,000. No dividends on common stock were
declared during the 3 years.
a. Determine the return on total assets, the return on stockholders' equity, and the return on common stockholders' equity
for Years 2 and 3. If required, round your answers to one decimal place.
Year 3
Year 2
Return on Total Assets
12
%
16
%
Return on Stockholders' Equity
15
%
22.8
%
Return on Common Stockholders' Equity
16.3
%
25.8
%
b. What conclusion can be drawn from these data as to the company's profitability?
The profitability ratios indicate that The Winter Group's profitability has deteriorated v
Most of this change is from net
income falling v
in Year 3. There is negative X
leverage from use of debt.](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2F206d89e9-8ef7-4259-8eaa-2d138f09119d%2F45c6e86d-ebbf-4530-9892-5bd5904aeb92%2Faaxft3co_processed.png&w=3840&q=75)
Transcribed Image Text:Dec. 31, Year 3
Dec. 31, Year 2
Dec. 31, Year 1
Total assets
$3,000,000
$2,700,000
$2,400,000
Notes payable (10% interest)
1,000,000
1,000,000
1,000,000
Common stock
400,000
400,000
400,000
Preferred $6 stock, $100 par
200,000
200,000
200,000
Retained earnings
1,126,000
896,000
600,000
The Year 3 net income was $242,000 and the Year 2 net income was $308,000. No dividends on common stock were
declared during the 3 years.
a. Determine the return on total assets, the return on stockholders' equity, and the return on common stockholders' equity
for Years 2 and 3. If required, round your answers to one decimal place.
Year 3
Year 2
Return on Total Assets
12
%
16
%
Return on Stockholders' Equity
15
%
22.8
%
Return on Common Stockholders' Equity
16.3
%
25.8
%
b. What conclusion can be drawn from these data as to the company's profitability?
The profitability ratios indicate that The Winter Group's profitability has deteriorated v
Most of this change is from net
income falling v
in Year 3. There is negative X
leverage from use of debt.
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