Chapter 10, Problem 4AP

1.

To determine

Calculate the return on equity for Company AE and Company B. Identify the company having higher return on equity.

Explanation of Solution

Return on equity ratio: Rate of return on equity ratio is used to determine the relationship between the net income available for the common stockholders’ and the average common equity that is invested in the company.

$\text{Return on Equity}\text{=}\frac{\text{Net}\text{Income}}{\text{Average}\text{Total}\text{Stockholder'}\text{Equity}}$

Calculate Company AE’s return on equity:

Given, Net income of Company AE is $204,163 and total stockholders’ equity at beginning and at ending are $1,204,569 and $1,246,791 respectively.

$\begin{array}{c}\text{Return on Equity}\text{=}\frac{\text{Net}\text{Income}}{\text{Average}\text{Total}\text{Stockholder'}\text{Equity}}\\ =\frac{\$204,163}{\left(\$1,204,569+\$1,246,791\right)÷2}\\ =\frac{\$204,163}{\$1,225,680}\\ =16.65\%\end{array}$

Therefore, return on assets of Company AE is 16.65%.

Calculate Company B’s return on equity:

Given, Net income of Company B is $89,707 and total stockholders’ equity at beginning and at ending are $391,248 and $430,539 respectively.

$\begin{array}{c}\text{Return on Equity}\text{=}\frac{\text{Net}\text{Income}}{\text{Average}\text{Total}\text{Stockholder'}\text{Equity}}\\ =\frac{\$89,707}{\left(\$391,248+\$430,539\right)÷2}\\ =\frac{\$89,707}{\$410,893.5}\\ =21.83\%\end{array}$

Therefore, return on assets of Company B is 21.83%.

Conclusion

Therefore, Company B is having higher return on equity as compared to Company AE.

2.

To determine

Calculate the dividend yield for Company AE and Company B. Identify the company having higher dividend yield.

Explanation of Solution

Dividend yield: Dividend yield ratio indicates how much percentage of share prices a company pays out in the form of dividends price. The formula to calculate the dividend yield percentage is as follows:

$\text{Dividend yield=}\frac{\text{Dividend per Share }}{\text{Market Price per Share}}$

Calculate the dividend yield for Company AE:

Given, the dividend per share is $0.512 $\left(\$90,858÷177,316\right)$ and market price per share is $17.56.

$\begin{array}{c}\text{Dividend yield=}\frac{\text{Dividend per Share }}{\text{Market Price per Share}}\\ =\frac{\$0.512}{\$17.56}\\ =2.91\%\end{array}$

Therefore, dividend yield for Company AE is 2.91%.

Calculate the dividend yield for Company B:

Given, the dividend per share is $2.7424 $\left(\$133,874÷48,816.170\right)$ and market price per share is $19.60.

$\begin{array}{c}\text{Dividend yield=}\frac{\text{Dividend per Share }}{\text{Market Price per Share}}\\ =\frac{\$2.7424}{\$19.60}\\ =13.99\%\end{array}$

Therefore, dividend yield for Company B is 13.99%.

Conclusion

Therefore, Company B is having higher dividend yield ratio.

3.

To determine

Calculate the Price/Earnings ratio for Company AE and Company B. Identify the company trading at a lower price per dollar of earnings.

Explanation of Solution

Price/Earnings Ratio: It depicts the relation of market price of a share to earnings per share of that company. The price/earnings ratio presents the market value of the amount invested to earn $1 by a company. It is major tool to be used by investors before the decisions related to investments in a company.

$\text{Price/Earnings Ratio}\text{=}\frac{\text{Market Price per Share }}{\text{Earnings per Share}}$

Calculate the price-earnings ratio for Company AE:

Given, market price per share is $17.56 and earnings’ per share is $1.15 (taken from income statement).

Calculate the price-earnings ratio:

$\begin{array}{c}\text{Price/Earnings Ratio}\text{=}\frac{\text{Market Price per Share }}{\text{Earnings per Share}}\\ =\frac{\$17.56}{\$1.15}\\ =15.27\text{times}\end{array}$

Therefore, price earnings ratio is 15.27 times.

Calculate the price-earnings ratio for Company B:

Given, market price per share is $19.60 and earnings’ per share is $1.86 (taken from income statement).

Calculate the price-earnings ratio:

$\begin{array}{c}\text{Price/Earnings Ratio}\text{=}\frac{\text{Market Price per Share }}{\text{Earnings per Share}}\\ =\frac{\$19.60}{\$1.86}\\ =10.54\text{times}\end{array}$

Therefore, price earnings ratio is 10.54 times.

Conclusion

Company B is trading at a lower price per dollar of earnings.