Exam 4: Profitability Analysis

The rationale for adding back the _______________________________________________________ relates to attaining consistency in the numerator and denominator of ROA.

Grundig Technologies is a manufacturer.Below are the company's two most recent balance sheets and its most recent income statement.Use this information to answer the following questions: a.Calculate the rate of return on assets (ROA)for 2011.Disaggregate ROA into the profit margin for ROA and total assets turnover components. b.Calculate the rate of return on common stockholders' equity (ROCE)for 2011.Disaggregate ROCE into the profit margin for ROCE,total assets turnover and capital structure leverage components. c.Did financial leverage work to the advantage of the common shareholders during 2011? Explain. Gitudig \& echinologies Balance Sheet As of December 31 ASSETS Cash \ 69,000 \ 22,000 Accounts Receivable 82,000 66,000 Supplies 15,000 19,000 Inventories 180,000 189,000 Land 75,000 110,000 Equipment 260,000 200,000 Accumulated Deprec.-EQ. (69,000) (42,000) TOTAL ASSETS \ 612,000 \ 564,000 Accounts Payable \ 34,000 \ 47,000 Unearned Rent 15,000 19,000 Bonds Payable 150,000 200,000 Stockholders' Equity Common Stock( \1 Par Value) 214,000 164,000 Retained Earnings 199,000 134,000 TOTAL LIABILITIES AND EQUITY \ 612.000 \ 564,000 Grundig Technologies Income Statement For the year ended December 31,2011 Sales \ 560,000 Cost of Goods Sold \ 320,000) Gioss Profit \ 240,000 General and Administrative Expense (\ 38,000) Selling Expense (\ 27,000) Interest Expense (\ 17,000) Income before Income taxes \ 158,000 Income Tax Expense (35\%) \ 158,000 Net Income (\ 55,300)

Return on assets will likely differ across firms and across time.Three elements of risk that will help explain these differences are operating leverage,___________________________________,and stage and length of product life cycle.

The ____________________ effect of interest expense on net income equals one minus the marginal tax rate times the interest expense.

Orca Industries Below are the two most recent balance sheets and most recent income statement for Orca Industries.The company has an effective tax rate of 35%. Balance Sheet Assets: Cash Accounts Receivable (net) Inventory Long-lived assets Less: Accumulated depreciation Total assets 2011 2010 \ 10,000 \ 6,000 6,000 1,500 8,000 10,000 12,000 11,000 $\text { Liabilities and Stockholders' Equity: }$ Accounts payable \ 5,000 \ 6,000 Deferred revenues 1,000 2,000 Long-term note payable 10,000 10,000 Less: Discount on note payable (800) (1,000) Common stock 12,000 6,000 Retained earnings Total liabilities and stockholders' equity Income Statement For the year ended December 31, 2011 Revenues \4 2,000 Cast af goods sold (24,000) Depreciation expense (2,000) Interest expense (3,000) Bad debt exanense (2,000) Other expense (including income taxes) Net incame -Refer to the information for Orca Industries.The profit margin for computing ROA for Orca Industries is:

Use the following information about Sanibel Corporation to calculate the following ratios for 2011 (assume an effective tax rate of 35%): a.Return on Assets b.Profit margin for ROA c.Assets Turnover d.Return on Common Shareholders' Equity e.Profit Margin for ROCE f.Accounts Receivable Turnover g.Inventory Turnover h.Fixed Asset Turnover Sanibel Corporation Balance Sheet As of December 31 , Assets: Cash and cash equivalents Accounts Receivable Inventory Current Assets 2011 2010 \ 712,300 \ 425,000 408,000 106,250 510.000 612.000 1,630,300 1,143,250 Equipment Less: Accumulated depreciation Land Total assets 714,000 654,500 (238,000) (119,000) 425,000 170,000 \ 2,531,300 \ 1,848,750 Liabilities Accounts Payable \ 297,500 \ 382,500 Accrued Salaries Payable 93,500 136,000 Rent Expense Payable 37,400 17,000 Income Tax Payable 117.300 68.000 Current Liabilities 545,700 603,500 Long-term note payable 850,000 510,000 Total Liabilities 1,395,700 1,113,500 Stockholders' Equity: Common stock 714,000 510,000 Retained earnings 421.600 225,250 Total liabilities and stockholders' equity \ 2,531,300 \ 1,848,750 Sanibel Corporation Income Statement For the year ended December 31,2011 Revenues \ 2,499,000 Cost of goods sold (1,428,000) Gross Profit 1,071,000 Operating Expenses Depreciation expense (112,000) Salary expense (233,600) Insurance Expense (40,000) Rent Expense (160,000) Interest Expense (67.200) Total Operating Expenses (612,800) Income from Operations 458,200 Income Tax Expense (160,370) Net income \ 297.830

Common-size analysis requires the analyst to be aware that percentages can change because of all of the following except:

Hall and Porter argue that firms have two generic alternative strategies for any particular product.These strategies are:

To calculate diluted EPS,the accountant does all of the following except:

The ability of a firm to generate income from operations given a particular level of sales is measured by the ______________________________.

Rattigan Industries reported net income (amounts in thousands)for Year 4 of $60,615 on sales of $1,560,235.It declared preferred dividends of $22,100.Preferred shareholders' equity totaled $265,750 at both the beginning and end of Year 4.Common shareholders' equity totaled $298,150 at the beginning of Year 4 and $365,000 at the end of Year 4.Rattigan had no minority interest in its equity.Total assets were $1,440,000 at the beginning of Year 4 and $1,550,000 at the end of Year 4.

Below are three relationships that are important to the determination of profitability.Assume assets were $22,900,000 on Dec.31,2008. 1. Operating leverage $= \underline { \text { Earnings before interest but after taxes } }$ Average assets. 2. Financial structure leverage $= \frac { \text { Net income available to common shareholders } } { \text { Earnings before interest but after taxes } }$ 3. $\mathrm { ROCE } = \mathrm { ROA } \times$ Common earnings leverage $\times$ Financial structure leverage REQUIRED: Compute the operating leverage, financial structure leverage, and ROCE (rounded to two places). Then use these relationships to analyze how the profitability of X-Mart changed over the three year period below. What does the company need to do to reverse this trend? What are the risks of your strategy? As of Dec. 31 ROA 0.10 0.10 0.08 Assets \ 27,500,000 \ 23,000,000 \ 27,600,000 Net income available to common shareholders \ 67,250,000 \ 68,960,210 \ 70,910,840 Earnings after taxes but before interest \ 25,000,000 \ 24,541,000 \ 24,794,000

Which of the following is not a way a company can achieve a low-cost position?

Orca Industries Below are the two most recent balance sheets and most recent income statement for Orca Industries.The company has an effective tax rate of 35%. Balance Sheet Assets: Cash Accounts Receivable (net) Inventory Long-lived assets Less: Accumulated depreciation Total assets 2011 2010 \ 10,000 \ 6,000 6,000 1,500 8,000 10,000 12,000 11,000 $\text { Liabilities and Stockholders' Equity: }$ Accounts payable \ 5,000 \ 6,000 Deferred revenues 1,000 2,000 Long-term note payable 10,000 10,000 Less: Discount on note payable (800) (1,000) Common stock 12,000 6,000 Retained earnings Total liabilities and stockholders' equity Income Statement For the year ended December 31, 2011 Revenues \4 2,000 Cast af goods sold (24,000) Depreciation expense (2,000) Interest expense (3,000) Bad debt exanense (2,000) Other expense (including income taxes) Net incame -Refer to the information for Orca Industries.Orca's basic earnings per share is:

One problem with using EPS as a measure of profitability is that it does not consider the amount of ____________________ or ____________________ required to generate a particular level of earnings.

When the financial analysts multiplies the profit margin for ROA with the assets turnover ratio the result is called ______________

Economic theory suggests that higher levels of ____________________ in any activity should lead to higher levels of ___________________________________.

Adjustments for dilutive securities and the adjustment to weighted average number of Shares outstanding presumes that the dilutive securities are converted to common shares:

Which of the following might an analyst not want to eliminate from past earnings when using past earnings to forecast future earnings?

Examine the four following conditions involving inventory turnover.Discuss what economic factors might be leading to the condition and whether it suggests positive or negative future economic conditions. Condition A: Increasing cost of goods sold to sales percentage, coupled with an increasing inventory turnover. Condition B: Decreasing cost of goods sold to sales percentage, coupled with a decreasinginventory turnover. Condition C: Increasing cost of goods sold to sales percentage, coupled with a decreasing inventory turnover. Condition D: Decreasing cost of goods sold to sales percentage, coupled with an increasing inventory turnover.