Chapter 11, Problem 5PB

Requirement – 1

To determine

Calculate the return on assets for both companies.

Answer to Problem 5PB

The return on assets of Company I and Company R is 5.7% and 13.8% respectively.

Explanation of Solution

Return on total Assets:

It is a measure to evaluate the efficiency of company’s assets. It reports the profit earned as the percentage of total assets used in the business. A company’s rate of return on total assets reflects its ability to optimize the use of total assets.

The formula to compute return on asset:

$\text{Return on Assets}=\frac{\text{Net income}}{\text{Average total assets}}$

The return on assets for both companies is as follows:

Company I:

$\begin{array}{c}\text{Return assets = }\frac{\$7,074\text{ million}}{\$127,010\text{ million(1)}}\times 100\\ =0.0570\times 100\\ =5.7\%\end{array}$

Company R:

$\begin{array}{c}\text{Return assets = }\frac{\$15,855\text{ million}}{\text{\$114,943 million (2)}}\times 100\\ =0.1379\times 100\\ =13.8\%\end{array}$

Calculate the average total assets of Company I.

$\begin{array}{c}\text{Average total assets = }\frac{\left(\begin{array}{l}\text{Beginning total assets+}\\ \text{Ending total assets}\end{array}\right)}{2}\\ =\frac{\$124,503\text{ million+129,517 million}}{2}\\ =\$127,010\text{million}\end{array}$ (1)

Calculate the average total assets of Company R.

$\begin{array}{c}\text{Average total assets = }\frac{\left(\begin{array}{l}\text{Beginning total assets+}\\ \text{Ending total assets}\end{array}\right)}{2}\\ =\frac{\$113,452\text{ million+116,433 million}}{2}\\ =\$114,943\text{ million}\end{array}$ (2)

Requirement – 2

To determine

Calculate the cash return on assets for both companies

Answer to Problem 5PB

The cash return on assets of Company I and Company R is 10.2% and 17.3% respectively.

Explanation of Solution

Cash return on assets:

It refers to the rate of cash generated from the investments in assets of company. It is relationship between the cash flows from operating activities and average total assets.

The formula to compute cash return on assets:

$\text{Cash return on assets = }\frac{\text{Cash flows from operating activities}}{\text{Average total assets}}$

The cash return on assets for both companies is as follows:

Company I:

$\begin{array}{c}\text{Cash return on assets = }\frac{\$12,639\text{ million}}{\$127,010\text{ million(1)}}\times 100\\ =0.1019\times 100\\ =10.2\%\end{array}$

Company R:

$\begin{array}{c}\text{Cash return on assets = }\frac{\$19,846\text{million}}{\text{\$114,943 million (2)}}\times 100\\ =0.1727\times 100\\ =17.3\%\end{array}$

Requirement – 3

To determine

Calculate the cash flow to sales ratio and asset turnover ratio for both companies:

Answer to Problem 5PB

The cash flow to sales ratio of Company I and Company R is 9.9% and 18.6% respectively, and assets turnover ratio of Company I and Company R is 1.0 times and 0.9 times respectively.

Explanation of Solution

Cash flows to sales:

It measures the cash generated from operating activities for each dollar of sales.

The formula to compute cash return on assets

$\text{Cash return on assets}=\frac{\text{Cash flows from operating activities}}{\text{Net sales}}$

Assets Turnover:

It’s a measure to evaluate the efficiency of total assets used in the business to generate sales during a certain period. Assets turnover reflects the net sales as the times of average total assets.

The formula to compute asset turnover

$\text{Asset Turnover}=\frac{\text{Net sales}}{\text{Average total assets}}$

The cash flow to sales ratio and asset turnover ratio for both companies are as follows:

Cash flow to sales ratio:

Company I:

$\begin{array}{c}\text{Cash flow to sales ratio}=\frac{\$12,639\text{million}}{\$127,245\text{ million}}\times 100\\ =0.099\times 100\\ =9.9\%\end{array}$

Company R:

$\begin{array}{c}\text{Cash flow to sales ratio}=\frac{\$19,846\text{ million}}{\$106,916\text{ million}}\times 100\\ =0.186\times 100\\ =18.6\%\end{array}$

Assets Turnover:

Company I:

$\begin{array}{c}\text{Assets turnover = }\frac{\$127,245\text{ million}}{\$127,010\text{million(1)}}\\ =1.0\text{ times}\end{array}$

Company R:

$\begin{array}{c}\text{Asset turnover= }\frac{\$106,916\text{ million}}{\text{\$114,943 million (2)}}\times 100\\ =0.9\text{ times}\end{array}$

Requirement – 4

To determine

Discuss the company that has more favorable ratios.

Explanation of Solution

• The return on asset of Company R is higher than Company I, hence Company R has favorable ratio.
• The cash return on asset of Company R is higher than Company I, hence the Company R has favorable ratio.
• The cash flows to sales of Company R is higher than Company I, hence the Company R has favorable ratio.
• The assets turnover ratio of Company I is higher than Company R, hence the Company I has favorable ratio.