Chapter 7, Problem 7.9BP

Calculate and Interpret ratios (LO7–7)

Papa’s Pizza is the market leader and Pizza Prince is an up-and-coming player in the highly competitive delivery pizza business. The companies reported the following selected financial data ($ in thousands):

	Papa’s Pizza	Pizza Prince
Net sales	$24,128	$ 1,835
Net income	2,23	129
Total assets, beginning	14,998	919
Total assets, ending	15,465	1,157

  Required:

  1.     Calculate the return on assets, profit margin, and asset turnover ratio for Papa’s Pizza.

  2.     Calculate the return on assets, profit margin, and asset turnover ratio for Pizza Prince.

  3.    Which company has the higher profit margin and which company has the higher asset turnover?

To determine

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

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:

$\begin{array}{c}\text{Rate of return on assets=}\frac{\text{Net}\text{income }}{\text{Average total assets (1)}}\\ \text{=}\frac{\text{\$2,223}}{\text{\$15,232}}\\ \text{=14}\text{.6\%}\end{array}$

Determine the average total assets:

$\begin{array}{c}\text{Average total assets = }\frac{\text{Total assets}\left(\text{Βeginning}\right)\text{+Total assets }\left(\text{Ending}\right)}{\text{2}}\\ \text{=}\frac{\text{\$14,998+\$15,465}}{\text{2}}\\ \text{=\$15,232}\end{array}$ (1)

Hence, the return on asset ratio is 14.6%.

• Determine the profit margin ratio:

The profit margin ratio is determined as follows:

$\begin{array}{c}\text{Profit margin ratio=}\frac{\text{Net}\text{income}}{\text{Net}\text{sales}}\text{×100}\\ \text{=}\frac{\text{\$2,223}}{\text{\$24,128}}\text{×100}\\ \text{=9}\text{.21\%}\end{array}$

Hence, the profit margin ratio is 9.21%.

Determine the asset turnover ratio:

The asset turnover ratio is determined as follows:

$\begin{array}{c}\text{Asset turnover =}\frac{\text{Net}\text{sales}}{\text{Average total assets}}\\ \text{=}\frac{\text{\$24,128}}{\text{\$15,232}}\\ \text{=1}\text{.6 Times}\end{array}$

Hence, the asset turnover ratio is 1.6 times.

To determine

To calculate: The PP company’s return on assets, profit margin and asset turnover for Pizza Prince.

Explanation of Solution

• Determine the return on assets ratio:

The return on assets ratio is determined as follows:

$\begin{array}{c}\text{Rate of return on assets=}\frac{\text{Net}\text{income }}{\text{Average total assets (2)}}\\ \text{=}\frac{\text{\$129}}{\text{\$1,038}}\\ \text{=12}\text{.42\%}\end{array}$

Determine the average total assets:

$\begin{array}{c}\text{Average total assets =}\frac{\text{Total assets}\left(\text{Βeginning}\right)\text{+Total assets }\left(\text{Ending}\right)}{\text{2}}\\ \text{=}\frac{\text{\$919+\$1,157}}{\text{2}}\\ \text{=\$1,038}\end{array}$ (2)

Hence, the return on asset ratio is 12.42%.

• Determine the profit margin ratio:

The profit margin ratio is determined as follows:

$\begin{array}{c}\text{Profit margin ratio=}\frac{\text{Net}\text{income}}{\text{Net}\text{sales}}\text{×100}\\ \text{=}\frac{\text{\$129}}{\text{\$1,835}}\text{×100}\\ \text{=7}\text{.02}\end{array}$

Hence, the profit margin ratio is 7.02%.

• Determine the asset turnover ratio:

Determine the asset turnover ratio is determined as follows:

$\begin{array}{c}\text{Asset turnover =}\frac{\text{Net}\text{sales}}{\text{Average total assets}}\\ \text{=}\frac{\text{\$1,835}}{\text{\$1,038}}\\ \text{=1}\text{.8 Times}\end{array}$

Hence, the asset turnover ratio is 1.8 Times.

To determine

To comment:  On the ratios.

Explanation of Solution

• Company P has higher profit margin when compared to Company PP.
• Company PP has higher asset turnover when compared to Company P.

Company P produces innovative products. Hence it has higher profit margins. Company PP emphasizes high sales turnover as it has competitive pricing strategies. The return on assets of company P is better than the Company PP.