Chapter 7, Problem 4AP

1.

To determine

Calculate the Company AE’s return on assets, profit margin, and asset turnover ratio.

Explanation of Solution

Return on assets: Return on assets is the financial ratio which determines the amount of net income earned by the business with the use of total assets owned by it. It indicates the magnitude of the company’s earnings with relative to its total assets.

$\text{Return on Assets }\left(\text{ROA}\right)=\frac{\text{Net}\text{Income}}{\text{Average}\text{Total}\text{Assets}}$

Given, Net income of Company AE is $204,163 and total assets at beginning and at ending are $1,816,313 and $1,782,660 respectively.

Calculate Company AE’s return on assets:

$\begin{array}{c}\text{Return on Assets }\left(\text{ROA}\right)=\frac{\text{Net}\text{Income}}{\text{Average}\text{Total}\text{Assets}}\\ =\frac{\$204,163}{\left(\$1,816,313+\$1,782,660\right)÷2}\\ =\frac{\$204,163}{\$1,799,487}\\ =11.3\%\end{array}$

Therefore, return on assets of Company AE is 11.3%.

Profit margin: Profit margin ratio is used to determine the percentage of net income that is being generated per dollar of revenue or sales.

$\text{Profit margin}\text{=}\frac{\text{Net}\text{Income}}{\text{Net Sales Revenue}}$

Given, net income is $201,163 and net sales revenue is $3,795,549.

Calculate Company AE’s profit margin:

$\begin{array}{c}\text{Profit margin}\text{=}\frac{\text{Net}\text{Income}}{\text{Net Sales Revenue}}\\ =\frac{\$204,163}{\$3,795,549}\\ =5.4\%\end{array}$

Therefore, profit margin of Company AE is 5.4%.

Total Asset turnover: Total asset turnover is a ratio that measures the productive capacity of the total assets to generate the sales revenue for the company. Thus, it shows the relationship between the net sales and the average total fixed assets.

$\text{Total Assets turnover}\text{ratio}\text{=}\frac{\text{Net}\text{Sales}\text{Revenue}}{\text{Average}\text{total}\text{Assets}}$

Given, net sales are $3,795,549 and total assets at beginning and at ending are $1,816,313 and $1,782,660 respectively.

Compute Company AE’s assets turnover:

$\begin{array}{c}\text{Total Assets turnover}\text{ratio}\text{=}\frac{\text{Net}\text{Sales}\text{Revenue}}{\text{Average}\text{total}\text{Assets}}\\ =\frac{\$3,795,549}{\left(\$1,816,313+\$1,782,660\right)÷2}\\ =\frac{\$3,795,549}{\$1,799,487}\\ =2.1\text{times}\end{array}$

Therefore, Company AE’s assets turnover is 2.1 times.

2.

To determine

Calculate the Company B’s return on assets, profit margin, and asset turnover ratio.

Explanation of Solution

Return on assets: Return on assets is the financial ratio which determines the amount of net income earned by the business with the use of total assets owned by it. It indicates the magnitude of the company’s earnings with relative to its total assets.

$\text{Return on Assets }\left(\text{ROA}\right)=\frac{\text{Net}\text{Income}}{\text{Average}\text{Total}\text{Assets}}$

Given, Net income of Company B is $89,707 and total assets at beginning and at ending are $538,116 and $579,847 respectively.

Calculate Company B’s return on assets:

$\begin{array}{c}\text{Return on Assets }\left(\text{ROA}\right)=\frac{\text{Net}\text{Income}}{\text{Average}\text{Total}\text{Assets}}\\ =\frac{\$89,707}{\left(\$538,116+\$579,847\right)÷2}\\ =\frac{\$89,707}{\$558,982}\\ =16.04\%\end{array}$

Therefore, return on assets of Company B is 16.04%.

Profit margin: Profit margin ratio is used to determine the percentage of net income that is being generated per dollar of revenue or sales.

$\text{Profit margin}\text{=}\frac{\text{Net}\text{Income}}{\text{Net Sales Revenue}}$

Given, net income is $89,707 and net sales revenue is $913,380.

Calculate Company B’s profit margin:

$\begin{array}{c}\text{Profit margin}\text{=}\frac{\text{Net}\text{Income}}{\text{Net Sales Revenue}}\\ =\frac{\$89,707}{\$913,380}\\ =9.8\%\end{array}$

Therefore, profit margin of Company B is 9.8%.

Total Asset turnover: Total asset turnover is a ratio that measures the productive capacity of the total assets to generate the sales revenue for the company. Thus, it shows the relationship between the net sales and the average total fixed assets.

$\text{Total Assets turnover}\text{ratio}\text{=}\frac{\text{Net}\text{Sales}\text{Revenue}}{\text{Average}\text{total}\text{Assets}}$

Given, net sales are $913,380 and total assets are at beginning and at ending are $538,116 and $579,847 respectively.

Compute Company B’s assets turnover:

$\begin{array}{c}\text{Total Assets turnover}\text{ratio}\text{=}\frac{\text{Net}\text{Sales}\text{Revenue}}{\text{Average}\text{total}\text{Assets}}\\ =\frac{\$913,380}{\left(\$538,116+\$579,847\right)÷2}\\ =\frac{\$913,380}{\$558,982}\\ =1.6\text{times}\end{array}$

Therefore, Company B’s assets turnover is 1.6 times.

3.

To determine

Identify the company which is doing better based on return on assets and find the company having higher profit margin and asset turnover.

Explanation of Solution

Find the company which is doing better based on return on assets and the company having higher profit margin and asset turnover:

Particulars	Company AE	Company B	Company  which is Better or having higher ratios
Return on assets	11.3%	16.04%	Company B
Profit margin	5.4%	9.8%	Company B
Assets turnover	2.1 times	1.6 times	Company AE

Table (1)

The above table indicates that Company B is having better return on assets and profit margin. Company AE is having better assets turnover.