Chapter 3, Problem 17P

a.

Summary Introduction

To calculate: The return on stockholders’ equity for Cable Corporation and Multi-Media Inc. and compute which firm has higher revenue.

Introduction:

Return on stockholders’ equity:

It is a profitability ratio that computes the capability of a company to generate profits out of the investments made by its shareholders.

Answer to Problem 17P

The return on stockholders’ equity for Cable Corporation is 13.05% and that for Multi-Media Inc.is 33.1%.

Multi-Media Inc. has higher returns on stockholders’ equity than Cable Corporation.

Explanation of Solution

Calculation of the return on stockholders’ equity for Cable Corporation:

$\begin{array}{c}\text{Return on stockholder's equity=}\frac{\text{Net income}}{\text{Stockholder's equity}}\\ =\frac{\$31,200}{\$239,000}\\ =13.05\%\end{array}$

Calculation of the return on stockholders’ equity for Multi-Media Inc.:

$\begin{array}{c}\text{Return on stockholder's equity=}\frac{\text{Net income}}{\text{Stockholder's equity}}\\ =\frac{\$140,000}{\$423,000}\\ =33.1\%\end{array}$

b.

Summary Introduction

To determine: The additional ratios for both the firms.

Introduction:

The ratio of net income to sales:

It is used to compute the profit margin ratio, which shows the degree to the company makes money from its business activities.

The ratio of net income to total assets:

It is used to compute the return on assets for the firm, which shows how efficiently a company uses its assets to generate profits.

The ratio of sales to total assets:

It is used to compute the asset turnover ratio of the company, which shows the capability of the assets of a company to generate sales or revenue.

Answer to Problem 17P

Calculation of additional ratios for Cable Corporation and Multi Media Incorporation:

Explanation of Solution

Explanatio n:

Calculation of the ratio of net income to sales for Cable Corporation:

$\begin{array}{c}\text{Ratio of net income to sales}=\frac{\text{Net income}}{\text{Sales}}\\ =\frac{\$31,200}{\$317,000}\\ =9.84\%\end{array}$

Calculation of the ratio of net income to total assets for Cable Corporation:

$\begin{array}{c}\text{Ratio of net income to total assets}=\frac{\text{Net income}}{\text{Total assets}}\\ =\frac{\$31,200}{\$402,000}\\ =7.76\%\end{array}$

Calculation of the ratio of sales to total assets for Cable Corporation:

$\begin{array}{c}\text{Ratio of sales to total assets}=\frac{\text{Sales}}{\text{Total assets}}\\ =\frac{\$317,000}{\$402,000}\\ =0.79\text{ times }\end{array}$

Calculation of the ratio of debt to total assets for Cable Corporation:

$\begin{array}{c}\text{Ratio of debt to total assets}=\frac{\text{Debt}}{\text{Total assets}}\\ =\frac{\$163,000}{\$402,000}\\ =40.55\%\end{array}$

Calculation of the ratio of net income to sales for Multi-Media Inc.:

$\begin{array}{c}\text{Ratio of net income to sales}=\frac{\text{Net income}}{\text{Sales}}\\ =\frac{\$140,000}{\$2,700,000}\\ =5.19\%\end{array}$

Calculation of the ratio of net income to total assets for Multi-Media Inc.:

$\begin{array}{c}\text{Ratio of net income to total assets}=\frac{\text{Net income}}{\text{Total assets}}\\ =\frac{\$140,000}{\$965,000}\\ =14.51\%\end{array}$

Calculation of the ratio of sales to total assets for Multi-Media Inc.:

$\begin{array}{c}\text{Ratio of sales to total assets}=\frac{\text{Sales}}{\text{Total assets}}\\ =\frac{\$2,700,000}{\$965,000}\\ =2.8\text{ times}\end{array}$

Calculation of the ratio of debt to total assets for Multi-Media Inc.:

$\begin{array}{c}\text{Ratio of debt to total assets}=\frac{\text{Debt}}{\text{Total assets}}\\ =\frac{\$542,000}{\$402,000}\\ =56.17\%\end{array}$

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c.

Summary Introduction

To explain: Whether the addition or detraction of factors from part (b) in one firm gives higher return on stockholders’ equity than the value of other firm that is computed in part (a).

Introduction:

Du point analysis:

It is a structure used for examining fundamental performance by comparing the operational efficiencies of two firms. It helps in scrutinizing the strengths and weaknesses that need to be addressed.

Answer to Problem 17P

The factor that leads to a higher return on total assets of Multi-Media Inc. is that the total asset turnover is more favorable for Multi-Media Inc. as compared to Cable Corporation. The total asset turnover for Multi-Media Inc. is 2.8 while that for Cable Corporation is 0.79.

The debt ratio of Multi-Media Inc. is also higher than that of Cable Corporation, which means that the total assets financed by stockholders’ equity is in a lesser percentage, which leads to higher returns on stockholders’ equity.

Explanation of Solution

The total asset turnover shows the capacity of a firm to generate revenue from its assets. The total asset turnover of Multi-Media Inc. is 2.8, which is more than the total asset turnover ratio of Cable Corporation of 0.79.

The debt ratio shows the leverage capacity of the company. Multi-Media Inc. has a higher debt ratio of 56.17% as compared to that of Cable Corporation, which is 40.55%.