Chapter 7, Problem 7.4APCA

1.

To determine

To calculate: The AE company’s return on assets, profit margin and asset turnover.

Explanation of Solution

Rate of return on total assets:

Rate of return on the total assets is the ratio of the net income, and interest expense to the average total assets. The rate of return on total assets measures the efficiency of the business. It measures how efficiently the business is using its total assets in generating the income.

The rate of return on the total assets is calculated as follows:

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

• Determine the return on assets ratio:

The return on assets ratio is determined as follows:

$\begin{array}{c}\text{Rate of return on assets=}\frac{\text{Net}\text{income }}{\text{Average total assets (1)}}\\ \text{=}\frac{\text{\$232,108}}{\text{\$1,853,427}\text{.5}}\\ \text{=12}\text{.5\%}\end{array}$

Determine the average total assets:

$\begin{array}{c}\text{Average total assets = }\frac{\text{Total assets}\left(\text{Βeginning}\right)\text{+Total assets }\left(\text{Ending}\right)}{\text{2}}\\ \text{=}\frac{\text{\$1,950,802+\$1,756,053}}{\text{2}}\\ \text{=\$1,853,427}\text{.5}\end{array}$ (1)

Hence, the return on asset ratio is 12.5%.

• Determine the profit margin ratio:

The profit margin ratio is determined as follows:

$\begin{array}{c}\text{Profit margin ratio=}\frac{\text{Net}\text{income}}{\text{Net}\text{sales}}\text{×100}\\ \text{=}\frac{\text{\$232,108}}{\text{\$3,475,802}}\text{×100}\\ \text{=6}\text{.7\%}\end{array}$

Hence, the profit margin ratio is 6.7%.

Determine the asset turnover ratio:

The asset turnover ratio is determined as follows:

$\begin{array}{c}\text{Asset turnover =}\frac{\text{Net}\text{sales}}{\text{Average total assets}}\\ \text{=}\frac{\text{\$3,475,802}}{\text{\$1,853,427}\text{.5}}\\ \text{=1}\text{.9 Times}\end{array}$

Hence, the asset turnover ratio is 1.9 times.

2.

To determine

To calculate: The B company’s return on assets, profit margin and asset turnover.

Explanation of Solution

• Determine the return on assets ratio:

The return on assets ratio is determined as follows:

$\begin{array}{c}\text{Rate of return on assets=}\frac{\text{Net}\text{income }}{\text{Average total assets (2)}}\\ \text{=}\frac{\text{\$164,305}}{\text{\$504,756}\text{.5}}\\ \text{=32}\text{.6\%}\end{array}$

Determine the average total assets:

$\begin{array}{c}\text{Average total assets =}\frac{\text{Total assets}\left(\text{Βeginning}\right)\text{+Total assets }\left(\text{Ending}\right)}{\text{2}}\\ \text{=}\frac{\text{\$531,539+\$477,974}}{\text{2}}\\ \text{=\$504,756}\text{.5}\end{array}$ (2)

Hence, the return on asset ratio is 32.6%.

• Determine the profit margin ratio:

The profit margin ratio is determined as follows:

$\begin{array}{c}\text{Profit margin ratio=}\frac{\text{Net}\text{income}}{\text{Net}\text{sales}}\text{×100}\\ \text{=}\frac{\text{\$164,305}}{\text{\$1,124,007}}\text{×100}\\ \text{=14}\text{.6\%}\end{array}$

Hence, the profit margin ratio is 14.6%.

• Determine the asset turnover ratio:

Determine the asset turnover ratio is determined as follows:

$\begin{array}{c}\text{Asset turnover =}\frac{\text{Net}\text{sales}}{\text{Average total assets}}\\ \text{=}\frac{\text{\$1,124,007}}{\text{\$504,756}\text{.5}}\\ \text{=2}\text{.2 Times}\end{array}$

Hence, the asset turnover ratio is 2.2 Times.

3.

To determine

To comment:  On the ratios.

Explanation of Solution

When comparing Company AE and Company B, the Company B’s ratios are higher than Company AE.