Chapter 11, Problem 11.2EYCT

(a)

To determine

Annual Report: It is a comprehensive financial report that shows all the business activities that takes place throughout the previous financial year. Its purpose is to provide the complete financial information of a company’s financial activities to its users in order to help them analyze and take well informed decisions.

Financial Ratios: Financial ratios are the metrics used to evaluate the overall financial performance of a company during a specific period of time.

To Compute: the return on common stockholders’ equity for Company CS and Company VF.

Answer to Problem 11.2EYCT

Compute the return on common stockholders’ equity:

For Company CS

  $\begin{array}{c}\begin{array}{l}\text{Return on common}\\ \text{stockholders' equity}\end{array}\}=\frac{\left(\begin{array}{l}\text{Net income–Preferred }\\ \text{dividends}\end{array}\right)}{\left(\begin{array}{l}\text{Average common }\\ \text{stockholders' }\\ \text{equity}\end{array}\right)}\times 100\\ =\frac{\$141,859–\$0}{\text{\$1,304,049}\left(1\right)}\times 100\\ =10.9\%\end{array}$

For Company VF

  $\begin{array}{c}\begin{array}{l}\text{Return on common}\\ \text{stockholders' equity}\end{array}\}=\frac{\left(\begin{array}{l}\text{Net income–Preferred }\\ \text{dividends}\end{array}\right)}{\left(\begin{array}{l}\text{Average common }\\ \text{stockholders' }\\ \text{equity}\end{array}\right)}\times 100\\ =\frac{\$1,047,505}{\$5,853,960\left(2\right)}\times 100\\ =17.9\%\end{array}$

Working notes:

Compute average stockholders’ equity for Company CS.

$\begin{array}{c}\begin{array}{l}\text{Average common}\\ \text{stockholders’ equity}\end{array}\}\text{=}\left(\frac{\begin{array}{l}\text{Beginning balance of stockholders’ equity }\\ \text{+}\text{Ending balance of stockholders’ equity }\end{array}}{\text{2}}\right)\\ \text{=}\frac{\text{\$1,355,234+\$1,252,864}}{\text{2}}\\ =\$1,304,049\end{array}$ (1)

Compute average stockholders’ equity for VF.

  $\begin{array}{c}\begin{array}{l}\text{Average common}\\ \text{stockholders’ equity}\end{array}\}\text{=}\left(\frac{\begin{array}{l}\text{Beginning balance of stockholders’ equity }\\ \text{+}\text{Ending balance of stockholders’ equity }\end{array}}{\text{2}}\right)\\ \text{=}\frac{\text{\$5,630,882+\$6,077,038}}{\text{2}}\\ =\$5,853,960\end{array}$ (2)

Explanation of Solution

Return on common stockholders’ equity ratio: It is a profitability ratio that measures the profit generating ability of the company from the invested money of the shareholders. The formula to calculate the return on common stockholders’ equity is as follows:

  $\begin{array}{l}\text{Return on common}\\ \text{stockholders' equity}\end{array}\}=\frac{\text{Net income–Preferred dividends}}{\text{Average common stockholders' equity}}\times 100$

Conclusion

Therefore, for Company CS the Return on Common Stockholders’ equity is 10.9% and, for Company VF the Return on Common Stockholders’ equity is 17.9%

To determine

To Compute: the debt to assets ratio for Company CS and Company VF.

Answer to Problem 11.2EYCT

Compute the debt to assets ratio:

For Company CS

  $\begin{array}{c}\text{Debt to assets ratio}]\text{ = }\frac{\text{Total liabilities}}{\text{Total assets}}\times 100\\ ==\frac{\$436,975}{\$1,792,209}\times 100\\ =24.4\%\end{array}$

For Company VF

  $\begin{array}{c}\text{Debt to assets ratio}]\text{ = }\frac{\text{Total liabilities}}{\text{Total assets}}\times 100\\ =\frac{\$4,349,258\left(3\right)}{\$9,980,140}\times 100\\ =43.6\%\end{array}$

Working note:

Compute total liabilities value for Company VF.

  $\begin{array}{c}\text{Total liabilities value = }\left\{\begin{array}{l}\text{Current liabilities + }\\ \text{Long-term debt + }\\ \text{Other liabilities}\end{array}\right\}\\ \text{= \$1,620,241+\$1,423,581+\$1,305,436}\\ \text{= \$4,349,258}\end{array}$ (3)

Explanation of Solution

Debt to assets ratio: It is the ratio that measures the ability of a company to meet its long-term obligations out of its total assets available. It shows the relationship of total liabilities and total assets.

The formula to calculate the debt to assets ratio is as follows:

  $\text{Debt to assets ratio}]\text{ = }\frac{\text{Total liabilities}}{\text{Total assets}}\times 100$

Conclusion

Therefore, for Company CS the Debt to assets ratio is 24.4% and, for Company VF the Debt to assets ratio is 43.6%.

To determine

To Compute: the return on assets ratio for Company CS and Company VF.

Answer to Problem 11.2EYCT

Compute the return on assets ratio:

For Company CS

  $\begin{array}{c}\text{Return on assets}]=\frac{\text{Net}\text{income}}{\text{Average total assets}}\times 100\\ =\frac{\$141,859}{\$1,698,898.5\left(4\right)}\times 100\\ =8.4\%\end{array}$

For Company VF

  $\begin{array}{c}\text{Return on assets}]=\frac{\text{Net}\text{income}}{\text{Average total assets}}\times 100\\ =\frac{\$1,047,505}{\$10,147,791.5\left(5\right)}\times 100\\ =10.3\%\end{array}$

Working notes:

Compute average total assets for Company CS.

  $\begin{array}{c}\text{Average total assets}=\frac{\left(\begin{array}{l}\text{Beginning balance of total assets+}\\ \text{Ending balance of total assets}\end{array}\right)}{2}\\ =\frac{\$1,792,209+\$1,605,588}{2}\\ =\$1,698,898.5\end{array}$ (4)

Compute average total assets for Company VF.

  $\begin{array}{c}\text{Average total assets}=\frac{\left(\begin{array}{l}\text{Beginning balance of total assets+}\\ \text{Ending balance of total assets}\end{array}\right)}{2}\\ =\frac{\$9,980,140+\$10,315,443}{2}\\ =\$10,147,791.5\end{array}$ (5)

Explanation of Solution

Return on assets is used to measure the overall earning ability of the company. Thus, it shows the relationship between the net income and the average total assets.

The formula to calculate the return on assets ratio is as follows:

  $\text{Return on assets}]=\frac{\text{Net}\text{income}}{\text{Average total assets}}\times 100$

Conclusion

Therefore, for Company CS the Return on assets is 8.4% and, for Company VF the Return on assets is 10.3%.

(b)

To determine

To explain: the conclusions concerning the companies’ profitability ratios can be drawn on these ratios.

Explanation of Solution

From the above calculated ratios in part a, the following conclusions can be drawn concerning both companies’ profitability:

• Return on assets for Company CS is 8.3% and that of Company VF is 10.3%. Thus, the higher ratio percentage of Company VF indicates that it is more profitable by generating more net income through effective utilization of total assets.
• Return on stockholders’ equity for Company CS is 10.9% and that of Company VF is 17.9%. Thus, the higher ratio percentage of Company VF indicates that it is more profitable as its shareholders earn more income from each equity share available to common stockholders.

To determine

To find: the company that relies more on debt to boost its return to common shareholders.

Answer to Problem 11.2EYCT

Company VF is the company that relies more on debt to boost its return to common shareholders.

Explanation of Solution

Debt to assets for Company VF is 43.6%. Thus, the higher ratio percentage of Company VF indicates that it relies more on the borrowed funds than its own available assets. Since its interest rate on borrowed funds is less than its return on assets, it provides more return on common stockholders’ equity than Company CS.

However, more reliance on debts than assets for Company VF would increase the risk of non-repayment of debts and would adversely affect its liquidity position.

(c)

To determine

To Compute: the payout ratio for Company CS and Company VF.

Answer to Problem 11.2EYCT

Compute the payout ratio:

For Company CS

  $\begin{array}{c}\text{Payout ratio = }\frac{\text{Cash dividend declared on common stock}}{\text{Net income}}\times 100\\ \text{=}\frac{\text{\$39,836,000}}{\text{\$141,859,000}}\text{×100}\\ \text{=28}\text{.1\%}\end{array}$

For Company VF

  $\begin{array}{c}\text{Payout ratio = }\frac{\text{Cash dividend declared on common stock}}{\text{Net income}}\times 100\\ \text{=}\frac{\text{\$478,933,000}}{\text{\$1,047,505,000}}\text{×100}\\ \text{=45}\text{.72\%}\end{array}$

Explanation of Solution

Payout Ratio: It refers to a measure that evaluates the amount of dividends paid to the shareholders out of the net income earned by a corporation. It is generally expressed as a percentage. The formula to calculate the payout ratio is as follows:

  $\text{Payout ratio = }\frac{\text{Cash dividend declared on common stock}}{\text{Net income}}\times 100$

Conclusion

Therefore, for Company CS the Payout ratio is 28.1% and, for Company VF the Payout ratio is 45.72%.

To determine

To find: which company pays out a higher percentage of its earnings.

Explanation of Solution

Corporation VF has higher percentage of payout ratio of 45.72% than Company CS of 28.1%.