Chapter 14, Problem 14.5BPR

To determine

1(a)

Financial Ratios: Financial ratios are the metrics used to evaluate the liquidity, capabilities, profitability, and overall performance of a company.

To determine: Return on total assets for five years (20Y4 to 20Y8)

Explanation of Solution

$\begin{array}{c}\text{Rate of return on assets}\left(\text{20Y8}\right)=\frac{\text{Net}\text{income + Interest expense}}{\text{Average total assets}}\\ =\frac{\$6,623,780}{\$25,988,665}\\ =25.5\%\end{array}$

$\begin{array}{c}\text{Rate of return on assets}\left(\text{20Y7}\right)=\frac{\text{Net}\text{income + Interest expense}}{\text{Average total assets}}\\ =\frac{\$4,606,056}{\$19,859,586}\\ =23.2\%\end{array}$

$\begin{array}{c}\text{Rate of return on assets}\left(\text{20Y6}\right)=\frac{\text{Net}\text{income + Interest expense}}{\text{Average total assets}}\\ =\frac{\$3,540,600}{\$14,854,406}\\ =23.8\%\end{array}$

$\begin{array}{c}\text{Rate of return on assets}\left(\text{20Y5}\right)=\frac{\text{Net}\text{income + Interest expense}}{\text{Average total assets}}\\ =\frac{\$2,458,000}{\$11,370,240}\\ =21.6\%\end{array}$

$\begin{array}{c}\text{Rate of return on assets}\left(\text{20Y4}\right)=\frac{\text{Net}\text{income + Interest expense}}{\text{Average total assets}}\\ =\frac{\$1,900,000}{\$8,676,000}\\ =21.9\%\end{array}$

Return on assets determines the particular company’s overall earning power. It is determined by dividing sum of net income and interest expense and average total assets.

Formula:

$\text{Rate of return on assets}=\frac{\text{Net}\text{income + Interest expense}}{\text{Average total assets}}$

1(b)

To determine

To determine: Return on stockholders’ equity for five years.

Explanation of Solution

$\begin{array}{c}\begin{array}{l}\text{Rate of return }\\ \text{on stockholders' equity}\left(\text{20Y8}\right)\end{array}\}=\frac{\text{Net income }}{\text{Average stockholder’s equity}}\\ =\frac{\$5,571,720}{\$15,920,340}\\ =35.0\%\end{array}$

$\begin{array}{c}\begin{array}{l}\text{Rate of return }\\ \text{on stockholders' equity}\left(\text{20Y7}\right)\end{array}\}=\frac{\text{Net income }}{\text{Average stockholder’s equity}}\\ =\frac{\$3,714,480}{\$11,277,240}\\ =32.9\end{array}$ $\begin{array}{c}\begin{array}{l}\text{Rate of return }\\ \text{on stockholders' equity}\left(\text{20Y6}\right)\end{array}\}=\frac{\text{Net income }}{\text{Average stockholder’s equity}}\\ =\frac{\$2,772,000}{\$8,034,000}\\ =34.5\%\end{array}$ $\begin{array}{c}\begin{array}{l}\text{Rate of return }\\ \text{on stockholders' equity}\left(\text{20Y5}\right)\end{array}\}=\frac{\text{Net income }}{\text{Average stockholder’s equity}}\\ =\frac{\$1,848,000}{\$5,724,000}\\ =32.3\%\end{array}$

$\begin{array}{c}\begin{array}{l}\text{Rate of return }\\ \text{on stockholders' equity}\left(\text{20Y4}\right)\end{array}\}=\frac{\text{Net income }}{\text{Average stockholder’s equity}}\\ =\frac{\$1,400,000}{\$4,100,000}\\ =34.1\%\end{array}$

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

Formula: $\text{Rate of return on stockholders' equtiy }=\frac{\text{Net income}}{\text{Average stockholder’s equity}}$

1(c)

To determine

To determine: Times interest earned ratio for five years

Explanation of Solution

$\begin{array}{c}\begin{array}{l}\text{Times-interest-}\\ \text{earned ratio }\left(\text{20Y8}\right)\end{array}\}=\frac{\text{Net Income}+\text{Income}\text{tax}\text{expense}+\text{Interest expense}}{\text{Interest expense}}\\ =\frac{\$7,849,352}{\$1,052,060}\\ =7.5\text{times}\end{array}$

$\begin{array}{c}\begin{array}{l}\text{Times-interest-}\\ \text{earned ratio }\left(\text{20Y7}\right)\end{array}\}=\frac{\text{Net Income}+\text{Income}\text{tax}\text{expense}+\text{Interest expense}}{\text{Interest expense}}\\ =\frac{\$5,451,278}{\$891,576}\\ =6.1\text{times}\end{array}$

$\begin{array}{c}\begin{array}{l}\text{Times-interest-}\\ \text{earned ratio }\left(\text{20Y6}\right)\end{array}\}=\frac{\text{Net Income}+\text{Income}\text{tax}\text{expense}+\text{Interest expense}}{\text{Interest expense}}\\ =\frac{\$4,180,920}{\text{\$768,600}}\\ =5.4\text{times}\end{array}$

$\begin{array}{c}\begin{array}{l}\text{Times-interest-}\\ \text{earned ratio }\left(\text{20Y5}\right)\end{array}\}=\frac{\text{Net Income}+\text{Income}\text{tax}\text{expense}+\text{Interest expense}}{\text{Interest expense}}\\ =\frac{\$2,899,600}{\text{\$6,10,000}}\\ =4.8\text{times}\end{array}$

$\begin{array}{c}\begin{array}{l}\text{Times-interest-}\\ \text{earned ratio }\left(\text{20Y4}\right)\end{array}\}=\frac{\text{Net Income}+\text{Income}\text{tax}\text{expense}+\text{Interest expense}}{\text{Interest expense}}\\ =\frac{\$2,220,000}{\text{\$500,000}}\\ =4.4\text{times}\end{array}$

Times interest earned ratio quantifies the number of times the earnings before interest and taxes can pay the interest expense. First, determine the sum of income before income tax and interest expense. Then, divide the sum by interest expense.

Formula:

$\begin{array}{l}\text{Times-interest-}\\ \text{earned ratio }\end{array}\}=\frac{\text{Income before income tax}+\text{Interest expense}}{\text{Interest expense}}$

1(d)

To determine

To determine: Ratio of liabilities to stockholders’ equity for five years (20Y4 to 20Y8)

Explanation of Solution

$\begin{array}{c}\begin{array}{l}\text{Ratio of liabilities to}\\ \text{ stockholders' equity}\left(\text{20Y8}\right)\end{array}\}=\frac{\text{Total liabilities}}{\text{Stockholders' equity}}\\ =\frac{\$10,672,291}{\$18,706,200}\\ =0.6\end{array}$\

$\begin{array}{c}\begin{array}{l}\text{Ratio of liabilities to}\\ \text{ stockholders' equity}\left(\text{20Y7}\right)\end{array}\}=\frac{\text{Total liabilities}}{\text{Stockholders' equity}}\\ =\frac{\$9,464,359}{\$13,134,480}\\ =0.7\end{array}$

$\begin{array}{c}\begin{array}{l}\text{Ratio of liabilities to}\\ \text{ stockholders' equity}\left(\text{20Y6}\right)\end{array}\}=\frac{\text{Total liabilities}}{\text{Stockholders' equity}}\\ =\frac{\$7,700,333}{\$9,420,000}\\ =0.8\end{array}$

$\begin{array}{c}\begin{array}{l}\text{Ratio of liabilities to}\\ \text{ stockholders' equity}\left(\text{20Y5}\right)\end{array}\}=\frac{\text{Total liabilities}}{\text{Stockholders' equity}}\\ =\frac{\$5,940,480}{\$6,648,000}\\ =0.9\end{array}$

$\begin{array}{c}\begin{array}{l}\text{Ratio of liabilities to}\\ \text{ stockholders' equity}\left(\text{20Y4}\right)\end{array}\}=\frac{\text{Total liabilities}}{\text{Stockholders' equity}}\\ =\frac{\$5,352,000}{\$4,800,000}\\ =1.1\end{array}$

Ratio of liabilities to stockholders’ equity is determined by dividing liabilities and stockholders’ equity. Liabilities are determined as the difference between ending balance of assets and stockholders’ equity.

Formula:

$\text{ Ratio of liabilities to stockholders' equity}=\frac{\text{Total liabilities}}{\text{Stockholders' equity}}$

To determine

To Display: The determined ratios in a graph

Explanation of Solution

Return on total assets

Figure (1)

Return on stockholders’ equity

Figure (2)

Times interest earned ratio

Figure (3)

Ratio of liabilities to stockholders’ equity

Figure (4)

2.

To determine

To prepare: Analysis of graphs

Explanation of Solution

• The return on total assets and return on stockholders’ equity are in increasing trend for the last five years. There is a positive use of leverage. It is evident through the above ratios.
• The ratio of liabilities to stockholders’ equity shows that the proportion of debt to stockholders’ equity is declining over the period.
• The level of debt has been relative to the equity and has improved in the five years.
• The times interest earned ratio is improving
• g when compared to industry average.