Chapter 17, Problem 17.5APR

1. a)

To determine

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

Given info: Items of financial statement

The Return on total assets for five years (2012 to 2016).

Explanation of Solution

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:

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

Return on total assets for five years (2012 to 2016) is calculated as below:

$\begin{array}{c}\text{Rate of return on assets}\left(\text{2016}\right)=\frac{\text{Net}\text{income + Interest expense}}{\text{Average total assets}}\\ =\frac{\$889,453}{\$4,270,764}\\ =20.8\%\end{array}$

$\begin{array}{c}\text{Rate of return on assets}\left(\text{2015}\right)=\frac{\text{Net}\text{income + Interest expense}}{\text{Average total assets}}\\ =\frac{\$939,979}{\$3,928,396}\\ =23.9\%\end{array}$

$\begin{array}{c}\text{Rate of return on assets}\left(\text{2014}\right)=\frac{\text{Net}\text{income + Interest expense}}{\text{Average total assets}}\\ =\frac{\$1,159,341}{\$3,535,472}\\ =32.8\%\end{array}$

$\begin{array}{c}\text{Rate of return on assets}\left(\text{2013}\right)=\frac{\text{Net}\text{income + Interest expense}}{\text{Average total assets}}\\ =\frac{\$1,379,000}{\$3,044,250}\\ =45.3\%\end{array}$

$\begin{array}{c}\text{Rate of return on assets}\left(\text{2012}\right)=\frac{\text{Net}\text{income + Interest expense}}{\text{Average total assets}}\\ =\frac{\$1,240,000}{\$2,475,000}\\ =50.1\%\end{array}$

b)

To determine

The Return on stockholders’ equity for five years (2012 to 2016).

Explanation of Solution

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

Return on stockholders’ equity for five years is calculated as below:

$\begin{array}{c}\begin{array}{l}\text{Rate of return }\\ \text{on stockholders' equity}\left(\text{2016}\right)\end{array}\}=\frac{\text{Net income }}{\text{Average stockholder’s equity}}\\ =\frac{\$273,406}{\$3,569,855}\\ =7.7\%\end{array}$

$\begin{array}{c}\begin{array}{l}\text{Rate of return }\\ \text{on stockholders' equity}\left(\text{2015}\right)\end{array}\}=\frac{\text{Net income }}{\text{Average stockholder’s equity}}\\ =\frac{\$367,976}{\$3,249,164}\\ =11.3\%\end{array}$

$\begin{array}{c}\begin{array}{l}\text{Rate of return }\\ \text{on stockholders' equity}\left(\text{2014}\right)\end{array}\}=\frac{\text{Net income }}{\text{Average stockholder’s equity}}\\ =\frac{\$631,176}{\$2,749,588}\\ =23.0\%\end{array}$

$\begin{array}{c}\begin{array}{l}\text{Rate of return }\\ \text{on stockholders' equity}\left(\text{2013}\right)\end{array}\}=\frac{\text{Net income }}{\text{Average stockholder’s equity}}\\ =\frac{\$884,000}{\$1,992,000}\\ =44.4\%\end{array}$

$\begin{array}{c}\begin{array}{l}\text{Rate of return }\\ \text{on stockholders' equity}\left(\text{2012}\right)\end{array}\}=\frac{\text{Net income }}{\text{Average stockholder’s equity}}\\ =\frac{\$800,000}{\$1,150,000}\\ =69.6\%\end{array}$

c)

To determine

The Number of times interest charges are earned for five years (2012 to 2016).

Explanation of Solution

Number of times interest charges are earned 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:

$\begin{array}{l}\text{Number of times}\\ \text{ interest charges }\\ \text{are earned }\end{array}\}=\frac{\text{Income before income tax}+\text{Interest expense}}{\text{Interest expense}}$

Number of times interest charges are earned is calculated as below:

$\begin{array}{c}\begin{array}{l}\text{Number of times}\\ \text{ interest charges }\\ \text{are earned }\left(\text{20Y6}\right)\end{array}\}=\frac{\text{Net Income}+\text{Income}\text{tax}\text{expense}+\text{Interest expense}}{\text{Interest expense}}\\ =\frac{\$921,202}{\$616,047}\\ =1.5\text{times}\end{array}$

$\begin{array}{c}\begin{array}{l}\text{Number of times}\\ \text{ interest charges }\\ \text{are earned }\left(\text{2015}\right)\end{array}\}=\frac{\text{Net Income}+\text{Income}\text{tax}\text{expense}+\text{Interest expense}}{\text{Interest expense}}\\ =\frac{\$993,539}{\$572,003}\\ =1.7\text{times}\end{array}$

$\begin{array}{c}\begin{array}{l}\text{Number of times}\\ \text{ interest charges }\\ \text{are earned }\left(\text{2014}\right)\end{array}\}=\frac{\text{Net Income}+\text{Income}\text{tax}\text{expense}+\text{Interest expense}}{\text{Interest expense}}\\ =\frac{\$1,266,061}{\text{\$528,165}}\\ =2.4\text{times}\end{array}$

$\begin{array}{c}\begin{array}{l}\text{Number of times}\\ \text{ interest charges }\\ \text{are earned }\left(\text{2013}\right)\end{array}\}=\frac{\text{Net Income}+\text{Income}\text{tax}\text{expense}+\text{Interest expense}}{\text{Interest expense}}\\ =\frac{\$1,539,000}{\text{\$495,000}}\\ =3.1\text{times}\end{array}$

$\begin{array}{c}\begin{array}{l}\text{Number of times}\\ \text{ interest charges }\\ \text{are earned }\left(\text{2012}\right)\end{array}\}=\frac{\text{Net Income}+\text{Income}\text{tax}\text{expense}+\text{Interest expense}}{\text{Interest expense}}\\ =\frac{\$1,440,000}{\text{\$440,000}}\\ =3.3\text{times}\end{array}$

d)

To determine

The ratio of liabilities to stockholders’ equity for five years (2012 to 2016).

Explanation of Solution

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:

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

Ratio of liabilities to stockholders’ equity for five years (2012 to 2016) is calculated as below:

$\begin{array}{c}\begin{array}{l}\text{Ratio of liabilities to}\\ \text{ stockholders' equity}\left(\text{2016}\right)\end{array}\}=\frac{\text{Total liabilities}}{\text{Stockholders' equity}}\\ =\frac{\$710,621}{\$3,706,557}\\ =0.2\end{array}$

$\begin{array}{c}\begin{array}{l}\text{Ratio of liabilities to}\\ \text{ stockholders' equity}\left(\text{2015}\right)\end{array}\}=\frac{\text{Total liabilities}}{\text{Stockholders' equity}}\\ =\frac{\$691,198}{\$3,433,152}\\ =0.2\end{array}$

$\begin{array}{c}\begin{array}{l}\text{Ratio of liabilities to}\\ \text{ stockholders' equity}\left(\text{2014}\right)\end{array}\}=\frac{\text{Total liabilities}}{\text{Stockholders' equity}}\\ =\frac{\$667,267}{\$3,065,176}\\ =0.2\end{array}$

$\begin{array}{c}\begin{array}{l}\text{Ratio of liabilities to}\\ \text{ stockholders' equity}\left(\text{2013}\right)\end{array}\}=\frac{\text{Total liabilities}}{\text{Stockholders' equity}}\\ =\frac{\$904,500}{\$234,000}\\ =0.4\end{array}$

$\begin{array}{c}\begin{array}{l}\text{Ratio of liabilities to}\\ \text{ stockholders' equity}\left(\text{2012}\right)\end{array}\}=\frac{\text{Total liabilities}}{\text{Stockholders' equity}}\\ =\frac{\$1,200,000}{\$1,550,000}\\ =0.8\end{array}$

2.

To determine

To prepare: Analysis of graphs

Explanation of Solution

• The return on total assets and return on stockholders’ equity is negative trend for the last five years. These measures have moved below the industry average. The reason behind this might be due to decline in the amount of earnings earned.
• The use of debt is very evident from the ratio of liabilities to stockholders’ equity and it is in the declining pace.
• The level of debt has been relative to the equity and has improved in the five years.
• The times interest earned ratio is below the industry average.