Chapter 7, Problem 9PA

1.

To determine

Calculate S 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:

$\begin{array}{c}\text{Rate of return on assets=}\frac{\text{Net}\text{income }}{\text{Average total assets (1)}}\\ \text{=}\frac{\text{\$25,992}}{\text{\$95,777}}\\ \text{=27}\text{.1\%}\end{array}$

Working note:

Determine the average total assets:

$\begin{array}{c}\text{Average total assets}=\frac{\text{Total assets}\left({\rm B}\text{eginning}\right)+\text{Total assets }\left(\text{Ending}\right)}{2}\\ =\frac{\$75,183+\$116,371}{2}\\ =\$95,777\end{array}$ (1)

Hence, the return on asset ratio is 27.1%.

Determine the profit margin ratio:

The profit margin ratio is determined as follows:

$\begin{array}{c}\text{Profit margin ratio=}\frac{\text{Net}\text{income}}{\text{Net}\text{sales}}\text{×100}\\ \text{=}\frac{\text{\$25,922}}{\text{\$108,249}}\text{×100}\\ \text{=24\%}\end{array}$

Hence, the profit margin ratio is 24%.

Determine the asset turnover ratio:

The asset turnover ratio is determined as follows:

$\begin{array}{c}\text{Asset turnover =}\frac{\text{Net}\text{sales}}{\text{Average total assets}}\\ \text{=}\frac{\text{\$95,777}}{\text{\$108,249}}\\ \text{=1}\text{.1 Times}\end{array}$

Hence, the asset turnover ratio is 1.1 times.

2.

To determine

Calculate P Company’s return on assets, profit margin and asset turnover ratio:

Explanation of Solution

Determine the return on assets ratio:

The return on assets ratio is determined as follows:

$\begin{array}{c}\text{Rate of return on assets=}\frac{\text{Net}\text{income }}{\text{Average total assets (2)}}\\ \text{=}\frac{\text{\$3,492}}{\text{\$41,566}}\\ \text{=8}\text{.40\%}\end{array}$

Working note:

Determine the average total assets:

$\begin{array}{c}\text{Average total assets}=\frac{\text{Total assets}\left({\rm B}\text{eginning}\right)+\text{Total assets }\left(\text{Ending}\right)}{2}\\ =\frac{\$38,599+\$44,533}{2}\\ =\$41,566\end{array}$ (2)

Hence, the return on asset ratio is 8.40%.

Determine the profit margin ratio:

The profit margin ratio is determined as follows:

$\begin{array}{c}\text{Profit margin ratio=}\frac{\text{Net}\text{income}}{\text{Net}\text{sales}}\text{×100}\\ \text{=}\frac{\text{\$3,492}}{\text{\$62,071}}\text{×100}\\ \text{=5}\text{.62\%}\end{array}$

Hence, the profit margin ratio is 5.62%.

Determine the asset turnover ratio:

Determine the asset turnover ratio is determined as follows:

$\begin{array}{c}\text{Asset turnover =}\frac{\text{Net}\text{sales}}{\text{Average total assets}}\\ \text{=}\frac{\text{\$62,071}}{\text{\$41,566}}\\ \text{=1}\text{.50 Times}\end{array}$

Hence, the asset turnover ratio is 1.50 Times.

3.

To determine

Comment on the ratios.

Explanation of Solution

• Company S has higher profit margin when compared to Company P.
• Company P has higher asset turnover when compared to Company S.
• Company S produces innovative products. Hence it has higher profit margins. Company
  P emphasizes high sales turnover as it has competitive pricing strategies.