Concept Introduction:
Profitability Measures:
The set of ratios that determines the ability of the company to create earnings or profits with respect to its sales or investments refers to profitability measures or profitability ratios.
Requirement A1:
To calculate:
The
Answer to Problem 11.13P
The return on investment for the year 2017 based on net income and average total assets of Wiper Inc is 8.82%
The return on investment for the year 2016 based on net income and average total assets of Wiper Inc is 7.77%
Explanation of Solution
In order to compute the return on investment, the margin and turnover should be determined.
Calculation of Margin for 2017:
The margin is computed by using the formula:
Margin= Net income/Sales*100 From the income statement of Wiper Inc 2017,
Net income or earnings: $300 million
Sales: $3,300 million
Therefore using the formula, net profit margin is:
Margin= $300/$3,300*100
Margin for the year 2017= 0.0909 or 9.09%
Calculation of Margin for 2016:
The margin is computed by using the formula:
Margin= Net income/Sales*100 From the income statement of Wiper Inc 2016,
Net income or earnings: $230 million
Sales: $2,900 million
Therefore using the formula, net profit margin is:
Margin= $230/$2,900*100
Margin for the year 2016= 0.0793 or 7.93%
Calculation of turnover for 2017:
From the income statement and
Sales: $3,300 million
Average total assets: $3,400 millionThe formula for computing turnover or total assets turnover is:
Turnover= Sales/Average total assets Turnover=$3,300/$3,400
Turnover for the year 2017= 0.9705 or 0.97 times
Calculation of turnover for 2016:
From the income statement of Wiper Inc 2016,
Sales: $2,900 million
Average total assets: $2,950 millionThe formula for computing turnover or total assets turnover is:
Turnover= Sales/Average total assets Turnover= $2,900/$2,950
Turnover for the year 2016= 0.9830 or 0.98 times
Calculation of Return on investments (ROI) for 2017:
The formula for computing return on investment using net income and average total assets is:
Return on investments=Margin*Turnover
i.e. Return on investments = [Net Income/Sales]*[Sales/Total Assets] From the margin and turnover calculated as above,
Margin= 9.09%
Turnover= 0.97
Return on investments= 9.09%*0.97
Return on investments for the year 2017= 8.82%
Calculation of Return on investments (ROI) for 2016:
The formula for computing return on investment using Dupont Model is:
Return on investments=Margin*Turnover
i.e. Return on investments = [Net Income/Sales]*[Sales/Total Assets] From the margin and turnover calculated as above,
Margin= 7.93%
Turnover= 0.98
Return on investments= 7.93%*0.98
Return on investments for the year 2016= 7.77%
Concept Introduction:
Profitability Measures:
The set of ratios that determines the ability of the company to create earnings or profits with respect to its sales or investments refers to profitability measures or profitability ratios.
Requirement b:
To calculate:
The return on equity of Wiper Inc from the given data for the year 2017 and 2016 to measure the ability of the company in generating profits from its investments.
Answer to Problem 11.13P
The return on equity of Wiper Inc for the year 2017 is 21.43%
The return on equity of Wiper Inc for the year 2016 is 20%
Explanation of Solution
Calculation of Return on Equity for 2017:
The formula for computing return on equity is:
Return on equity= Net income/Shareholder's equity*100 From the income statement and balance sheet of Wiper Inc 2017,
Net income or earnings: $300 million
Average total
Therefore using the formula, return on equity is:
Return on equity= $300/$1,400*100
Return on equity for the year 2017= 21.43%
Calculation of Return on Equity for 2016:
The formula for computing return on equity is:
Return on equity= Net income/Shareholder's equity*100 From the income statement and balance sheet of Wiper Inc 2016,
Net income or earnings: $230 million
Average total stockholder's equity: $1,150 million
Therefore using the formula, return on equity is:
Return on equity= $230/$1,150*100
Return on equity for the year 2016= 20%
Concept Introduction:
Liquidity Measures:
The set of ratios that measures the ability of the company to pay off its short-term debts or obligations by comparing the assets that can be easily convertible into cash or liquid assets with its short-term liabilities refers to liquidity measurement ratios.
Requirement c:
To calculate:
The working capital and current ratio of Wiper Inc for the past three years to measure the liquidity of the company.
Answer to Problem 11.13P
The working capital of Wiper Inc for three years are shown in below table:
| Year | Working Capital | Current Ratio |
| 2017 | $150 million | 1.3 |
| 2016 | $100 million | 1.125 |
| 2015 | 0 | 1 |
Explanation of Solution
Calculation of Working Capital:
The working capital is computed by using the formula:
Below table shows the calculation of working capital for three years:
| 2017 (in millions) | 2016 (in millions) | 2015 (in millions) | |
| A. Current Assets | $ 650 | $900 | $700 |
| B. Current Liabilities | $500 | $800 | $700 |
| Working Capital (A-B) | $150 | $100 | $0 |
Note: Current Assets and Current Liabilities are taken from the Condensed Balance Sheet of Wiper Inc given in the problem.
Calculation of Current Ratio:
The current ratio is computed by using the formula:
Current Ratio=Current Assets/Current Liabilities Below table shows the calculation of current ratio for three years:
| 2017 (in millions) | 2016 (in millions) | 2015 (in millions) | |
| A. Current Assets | $ 650 | $900 | $700 |
| B. Current Liabilities | $500 | $800 | $700 |
| Current Ratio (A/B) | 1.3 | 1.125 | 1 |
Note: Current Assets and Current Liabilities are taken from the Condensed Balance Sheet of Wiper Inc given in the problem.
Concept Introduction:
Investments Measures:
The set of ratios that measures the performance of shares of the company that are required by investors, analysts and competitors refers to investment ratios.
Requirement d:
To calculate:
The earnings per share of Wiper Inc for the year 2017 and 2016 to measure the profits of the company available to its common stockholders.
Answer to Problem 11.13P
The earnings per share of Wiper Inc for 2017 is %
The earnings per share of Wiper Inc for 2016 is %
Explanation of Solution
Calculation of earnings per share for 2017:
The formula for calculating earnings per share is:
Earnings per share= Net income/Average number of common shares outstanding From the income statement of Wiper Inc 2017,
Net income: $300 million
Average number of common shares outstanding: 44
Therefore using the above formula, earnings per share is:
Earnings per share= $300/44
Earnings per share for the year 2017= 2.97
Calculation of earnings per share for 2016:
The formula for calculating earnings per share is:
Earnings per share= Net income/Average number of common shares outstanding From the income statement of Wiper Inc 2016,
Net income: $230 million
Average number of common shares outstanding: 42
Therefore using the above formula, earnings per share is:
Earnings per share= $230/42
Earnings per share for the year 2016= 5.48
Concept Introduction:
Investments Measures:
The set of ratios that measures the performance of shares of the company that are required by investors, analysts and competitors refers to investment ratios.
Requirement e:
To calculate:
The market value of Wiper Inc if the price to earnings ratio of them is 14 at the year end of 2017.
Answer to Problem 11.13P
The market value of the stock of Wiper Inc if the price to earnings ratio of them is 14 at the year-end 2017 is $41.58.
Explanation of Solution
The market value of stock can be computed by using the price to earnings ratio formula:
Price to earnings ratio: 14
Earnings per share for 2017: $2.97 (As calculated in Requirement d above)
Therefore using the above formula, market value per share is:
14=Market value per share/$2.97
Market value per share=14*$2.97
Market value per stock or share of Wiper Inc= $41.58
Concept Introduction:
Dividend Policy Ratios:
The set of ratios that measures the amount paid out as dividends in relation to its earnings and market value of its shares refers to dividend policy ratios. Dividend pay-out ratio and dividend yield are the commonly used dividend policy ratios.
Requirement f
To calculate:
The cash dividend per share and the dividend yield of Wiper Inc for the year 2017 based on its market price.
Answer to Problem 11.13P
The cash dividend per share of Wiper Inc for the year 2017 is $1.14
The dividend yield of Wiper Inc for the year 2017 is 2.74%
Explanation of Solution
Calculation of cash dividend per share for 2017:
The cash dividend per share is computed by using the formula:
Dividend per share= Annual dividends paid/Number of shares outstanding From the income statement of Wiper Inc for 2017,
Total dividends paid: $50 millions
Number of common shares outstanding: 44
Therefore using the above formula, cash dividend per share is:
Cash dividend per share= $50/44
Cash dividend per share for 2017 = $1.1363 or $1.14Calculation of dividend yield for 2017:
The formula for calculating dividend yield is:
Dividends per share: $1.14
Market price per share at the year-end: $41.58
Therefore using the above formula, dividend yield is:
Dividend yield= $1.14/$41.58*100
Dividend yield for the year 2017= 2.74%
Concept Introduction:
Dividend Policy Ratios:
The set of ratios that measures the amount paid out as dividends in relation to its earnings and market value of its shares refers to dividend policy ratios. Dividend pay-out ratio and dividend yield are the commonly used dividend policy ratios.
Requirement g
To calculate:
The dividend pay-out ratio of Wiper Inc for the year 2017 to determine the percentage of its net earnings paid to dividends.
Answer to Problem 11.13P
The dividend pay-out ratio of Wiper Inc for the year 2017 is
Explanation of Solution
The formula for calculating dividend pay-out ratio is:
From the given data,
Dividends per share: $1.14 (As calculated in above Requirement f)
Earnings per share: $2.97 (As calculated in above Requirement d)
Therefore using the above formula, dividend pay-out ratio is:
Dividend pay-out ratio= $1.14/$2.97
Dividend pay-out ratio for the year 2017= 0.38 times or 38.77%
Concept Introduction:
Activity Measures:
The set of ratios that measures the relative efficiency of the company to generate revenues and cash from its resources refers to activity measurement ratios. It measures the efficiency of the company in using its assets to generate maximum possible revenue.
Requirement h
To calculate:
The number of day's sales in
Answer to Problem 11.13P
The number of day's sales in accounts receivables of Wiper Inc for the year 2017 using year end accounts receivables is 34.28 days.
Explanation of Solution
The formula for calculating day's sales in accounts receivables is:
Day's Sales in Accounts Receivables = [Accounts Receivables/Total Credit Sales]*365 Sales for the year 2017: $3,300 millionsAccounts receivables for the year end: $310 millions.
Therefore using the above formula, day's sales in accounts receivables is:
Day's sales in Accounts Receivables = [$310/$3,300]*365
Day's sales in Accounts Receivables for the year 2017= 34.28 days.
Concept Introduction:
Financial Leverage Measures:
The set of ratios that measures the ability of the company to meet its long-term financial obligations such as interest payments on debts, fixed lease payments refers to financial leverage measurement ratios. Financial leverage ratios are also called as debt ratio or equity ratio.
Requirement i
To calculate:
The debt ratio and debt to equity ratio of Wiper Inc for the year ended 2017 and 2016 to measure the financial leverage of the company.
Answer to Problem 11.13P
The debt ratio of the Wiper Inc for the year end 2017 is 0.59 times.
The debt ratio of the Wiper Inc for the year end 2016 is 0.61 times.
The debt to equity ratio of Wiper Inc for the year end 2017 is 1.43 times.
The debt to equity ratio of Wiper Inc for the year end 2016 is 1.56 times.
Explanation of Solution
Calculation of Debt Ratio for 2017:
The debt ratio is computed by using the formula:
From the Balance sheet of Wiper Inc 2017,
Total assets at year-end: $3,400 million.
Total liabilities= Current Liabilities+Long-term liabilities.
Total liabilities= $500+$1,500 million.
Total liabilities at year-end: $2,000 million
Therefore using the above formula, debt ratio is:
Debt Ratio= $2,000/$3,400
Debt Ratio for the year end 2017= 0.59 times
Calculation of Debt Ratio for 2016:
The debt ratio is computed by using the formula:
From the Balance sheet of Wiper Inc 2016,
Total assets at year-end: $2,950 million
Total liabilities= Current Liabilities+Long-term liabilities
Total liabilities= $800+$1,000 million
Total liabilities at year-end: $1,800 million
Therefore using the above formula, debt ratio is:
Debt Ratio= $1,800/$2,950
Debt Ratio for the year end 2016= 0.61 times
Calculation of Debt to Equity Ratio for 2017:
The formula for computing debt to equity ratio is:
Total liabilities at year-end: $2,000 million
Total shareholder's equity: $1,400 million
Therefore using the above formula, debt to equity ratio is:
Debt to Equity Ratio = $2,000/$1,400
Debt to Equity Ratio for the year 2017= 1.43 times
Calculation of Debt to Equity Ratio for 2016:
The formula for computing debt to equity ratio is:
Total liabilities at year-end: $1,800 million
Total shareholder's equity: $1,150 million
Therefore using the above formula, debt to equity ratio is:
Debt to Equity Ratio = $1,800/$1,150
Debt to Equity Ratio for the year 2016= 1.56 times
Concept Introduction:
Financial leverage measures:
The set of ratios that measures the ability of the company to meet its long-term financial obligations such as interest payments on debts, fixed lease payments refers to financial leverage measurement ratios. Financial leverage ratios are also called as debt ratio or equity ratio.
Requirement j
To calculate:
The times interest earned of Wiper Inc for the year 2017 and 2016 to measure the ability of the company to meet its debt obligations.
Answer to Problem 11.13P
The times interest earned of Wiper Inc for the year 2017 is 4.75 times.
The times interest earned of Wiper Inc for the year 2016 is 4.28 times.
Explanation of Solution
Calculation of times interest earned for 2017:
The formula for calculating times interest earned is:
From the income statement of Wiper Inc 2017,
Earnings before interest and taxes (Operating Income): $380 million
Interest Expense: $80 million
Therefore using the above formula, times interest earned is:
Times interest earned = $380/$80
Times interest earned for 2017= 4.75 times
Calculation of times interest earned for 2016:
The formula for calculating times interest earned is:
From the income statement of Wiper Inc 2016,
Earnings before interest and taxes (Operating Income): $300 million
Interest Expense: $70 million
Therefore using the above formula, times interest earned is:
Times interest earned = $300/$70
Times interest earned for 2016= 4.28 times
Concept Introduction:
Profitability Measures:
The set of ratios that determines the ability of the company to create earnings or profits with respect to its sales or investments refers to profitability measures or profitability ratios.
Liquidity Measures:
The set of ratios that measures the ability of the company to pay off its short-term debts or obligations by comparing the assets that can be easily convertible into cash or liquid assets with its short-term liabilities refers to liquidity measurement ratios. Current ratio, acid-test ratio, working capital are the most used liquidity ratios in the business.
Requirement k
To evaluate:
The profitability and liquidity of Wiper Inc and its suitability as an investment to invest in its common stock.
Answer to Problem 11.13P
The profitability and liquidity ratios determined in the above requirements highlights that both the profitability and liquidity for the year 2017 is improved compared to the profitability and liquidity of the year 2016. Hence the investment is highly suitable for a young, single professional to invest funds in common stock of Wiper Inc.
Explanation of Solution
The profitability and liquidity ratios of Wiper Inc is:
The profitability ratios of return on investment and return on equity for the year 2017 is 8.82% and 21.43% respectively.
The profitability ratios of return on investment and return on equity for the year 2016 is 7.77% and 20% respectively.
The liquidity ratios of working capital and current ratio for the year 2017 is $150 million and 1.3 respectively.
The liquidity ratios of working capital and current ratio for the year 2016 is $100 million and 1.125 respectively.
Hence from evaluating both the years, the profitability and liquidity ratios for the year 2017 highlights the better trend comparing to the year 2016 which is highly suitable for investments.
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Chapter 11 Solutions
Accounting: What the Numbers Mean
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