Chapter 9, Problem 8PB

1.

To determine

Calculate the debt to equity ratio for Company SC and PF for the most recent year, and state the company that has higher debt to equity ratio.

Explanation of Solution

Debt to equity ratio:

The ratio of company’s total debt to the total stockholders’ equity is known as debt to equity ratio. The company is at risk if the debt to equity ratio is high because, the company’s equity is not enough to repay the debt at maturity along with the interest.

Calculate debt to equity ratio for Company SC:

$\begin{array}{c}\text{Debt Equity ratio}\text{=}\frac{\text{Total liabilites}}{\text{Stockholders' equity}}\\ =\frac{\$11,519\text{million}}{\$8,309\text{million}}\\ =1.39:1\end{array}$

Calculate debt to equity ratio for Company PF:

$\begin{array}{c}\text{Debt Equity ratio}\text{=}\frac{\text{Total liabilites}}{\text{Stockholders' equity}}\\ =\frac{\$15,232\text{million}}{\$23,929\text{million}}\\ =0.64:1\end{array}$

Therefore, from the above explanation, it is noted that, the debt to equity ratio of company SC (1.39:1) is higher than company PF (0.64:1).

2.

To determine

Calculate the return on assets for company SC and PF, and state the company that appears more profitable.

Explanation of Solution

Return on assets:

Return on assets determines the particular company’s overall earning power. It is determined by dividing net income and average total assets.

Calculate return on assets for Company SC:

$\begin{array}{c}\text{Return on assets =}\frac{\text{Net income }}{\text{Average total assets}}\\ =\frac{\$18\text{millions}}{\frac{\left(\$19,828+\$19,804\right)}{2}}\\ =\frac{\$18\text{million}}{\text{\$1,298}\text{million}}\\ =0.1\%\end{array}$

Calculate return on assets for Company PF:

$\begin{array}{c}\text{Return on assets =}\frac{\text{Net income }}{\text{Average total assets}}\\ =\frac{\$1,298\text{millions}}{\frac{\left(\$39,161+\$38,637\right)}{2}}\\ =\frac{\$1,298\text{million}}{\$38,899\text{million}}\\ =3.3\%\end{array}$

Note: Average total assets include opening balance of assets and closing balance of assets.

Therefore, from the above calculation, it is noted that, company PF (3.3%) is more profitable than company SC (0.1%).

3.

To determine

Calculate the times interest earned ratio for Company SC and PK and state the Company that can meet the interest expenses as they become due.

Explanation of Solution

Times interest earned ratio:

Times interest earned ratio quantifies the number of times the earnings before interest and taxes can pay the interest expense. First, determine the sum of income before income tax and interest expense. Then, divide the sum by interest expense.

Calculate time interest earned ratio for Company SC:

$\begin{array}{c}\text{Time interest earned ratio =}\frac{\text{Net income +}\text{Interest +}\text{Taxes}}{\text{Interest}}\\ \text{=}\frac{\text{\$18}\text{millions+\$356}\text{millions}}{\text{\$356}\text{millions}}\\ \text{=}\frac{\text{\$374}\text{millions}}{\text{\$356}\text{millions}}\\ \text{=}\text{1}\text{.1}\text{Times}\end{array}$

Note: There is no tax expense incurred for Company SC during the year 2021.

Calculate time interest earned ratio for Company PK:

$\begin{array}{c}\text{Time interest earned ratio =}\frac{\text{Net income +}\text{Interest +}\text{Taxes}}{\text{Interest}}\\ \text{=}\frac{\text{\$ 1,298}\text{millions+\$336}\text{millions+}\text{\$4}\text{millions}}{\text{\$336}\text{millions}}\\ \text{=}\frac{\text{\$1,638}\text{millions}}{\text{\$336}\text{millions}}\\ \text{=}\text{4}\text{.9}\text{Times}\end{array}$

The times interest earned ratio of Company PK is greater (4.9 times) while comparing to the times interest earned ratio of Company SC (1.1 times). Therefore, Company PK is able to meet its interest payments as they become due.