Chapter 15, Problem 58P

The following information has been gathered for Malette Manufacturing:

Assume that the firm has no common stock equivalents. The tax rate is 34%.

Required:

1. 1. Compute the return on assets.
2. 2. Compute the return on common stockholders’ equity.
3. 3. Compute the earnings per share.
4. 4. Compute the price-earnings ratio.
5. 5. Compute the dividend yield.
6. 6. Compute the dividend payout ratio.

To determine

Calculate return on assets.

Answer to Problem 58P

Return on assets is 0.088 or 8.8%.

Explanation of Solution

Profitability Ratio

These ratios evaluate a firm’s ability to earn profits. They help the stakeholders of the company to measure the degree to which funds invested by them are efficiently used. Some of the ratios calculated return on sales, total assets and stockholder’s equity.

Use the following formula to compute return on assets:

$\text{Return on assets}=\frac{\text{Net income}\left[\text{Interest expense}\left(1-\text{Tax rate}\right)\right]}{\text{Average assets}}$

Substitute the values in the above formula:

$\begin{array}{c}\text{Return on assets}=\frac{\text{Net income}+\left[\text{Interest expense}\left(1-\text{Tax rate}\right)\right]}{\text{Average assets}}\\ =\frac{5,000,000+\left[400,000\left(1-0.34\right)\right]}{60,000,000}\\ =\frac{5,264,000}{60,000,000}\\ =0.088\text{ or 8}\text{.8\%}\end{array}$

Therefore, return on assets is 8.8%.

To determine

Calculate return stockholders’ equity.

Answer to Problem 58P

Return on stockholders’ equity is 0.23 or 23%

Explanation of Solution

Use the following formula to compute return stockholders’ equity:

$\text{Return on stockholders' equity}=\frac{\text{Net income}-\text{Preferred dividends}}{\text{Average common stockholder's equity}}$

Substitute the values in the above formula:

$\begin{array}{c}\text{Return on stockholder's equity}=\frac{5,000,000-400,000}{20,000,000}\\ =\frac{4,600,000}{20,000,000}\\ =0.23\text{ or 23\%}\end{array}$

Therefore, return on stockholders’ equity is 0.23 or 23%.

To determine

Calculate earnings per share.

Answer to Problem 58P

Earnings per share is $5.75 per share

Explanation of Solution

Use the following formula to compute earnings per share:

$\text{Earnings per share}=\frac{\text{Net income}-\text{Preferred dividends}}{\text{Average common shares}}$

Substitute the values in the above formula:

$\begin{array}{c}\text{Earnings per share}=\frac{5,000,000-400,000}{800,000}\\ =\frac{4,600,000}{800,000}\\ =\$5.75\end{array}$

Therefore, earnings per share are $5.75 per share.

To determine

Calculate price earnings ratio.

Answer to Problem 58P

Price earnings ratio is 6.96.

Explanation of Solution

Use the following formula to compute price earnings ratio:

$\text{Price earnings ratio}=\frac{\text{Market price per share}}{\text{Earnings per share}}$

Substitute the values in the above formula:

$\begin{array}{c}\text{Price earnings ratio}=\frac{40}{5.75}\\ =6.96\end{array}$

Therefore, price earnings ratio is 6.96.

To determine

Calculate dividend yield.

Answer to Problem 58P

Divided yield is 0.0375 or 3.75%.

Explanation of Solution

Use the following formula to compute dividend yield:

$\text{Dividend yield}=\frac{\text{Dividends per common share}}{\text{Market price per share}}$

Substitute the values in the above formula:

$\begin{array}{c}\text{Dividend yield}=\frac{1.5}{40}\\ =0.0375\text{ or 3}\text{.75\%}\end{array}$

Therefore, dividend yield is 0.0375 or 3.75%.

Working notes

Calculation of dividend per common share:

$\begin{array}{c}\text{Dividends per common share}=\frac{\text{Common dividends}}{\text{Average}\text{common}\text{shares}\text{outstanding}}\\ =\frac{1,200,000}{800,000}\\ =\$1.5\end{array}$

To determine

Calculate dividend payout ratio.

Answer to Problem 58P

Dividend payout ratio is 0.26.

Explanation of Solution

Use the following formula to compute dividend payout ratio:

$\text{Dividend payout ratio}=\frac{\text{Common dividends}}{\text{Net income}-\text{Preferred dividends}}$

Substitute the values in the above formula:

$\begin{array}{c}\text{Dividend payout ratio}=\frac{1,200,000}{5,000,000-400,000}\\ =\frac{1,200,000}{4,600,000}\\ =0.26\end{array}$

Therefore, dividend payout ratio is 0.26.