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Chapter 8
Profitability
PROBLEMS
PROBLEM 8-1
Net Profit Margin =
2004 2003
5.00% 4.00%
Return on Assets =
2004 2003
22.83% 20.00%
Total Asset Turnover =
2004 2003
4.57 times 5.00 times
per year per year
= Return on Common Equity =
2004 2003
30.88% 25.00%
Ahl Enterprise has had a substantial rise in profit to sales. This is somewhat tempered by a reduction in asset turnover. Given a slight rise in common equity, there is a substantial rise in return on common equity.
PROBLEM 8-2
a.
2004
2003
Sales
Cost of goods sold
Gross profit
Selling expense
General expense
Operating income
Income tax
Net income
100.0%
60.7
39.3
14.6
10.0
14.7
5.9
8.8%
100.0%
60.8
39.2
20.0
8.3
10.9
4.2
6.7%
b. Starr Canning has had a sharp decrease in selling expense coupled with only a modest rise in general expenses giving an overall rise in the net profit margin.
PROBLEM 8-3
Earnings Before interest and tax $245,000
Interest (750,000 x 6%) 45,000
Earnings before tax $200,000
Tax 80,000
Net income $120,000
Preferred dividends 15,000
Income available to common $105,000
a.
b.
c.
d.
= 5.44 times
per year
PROBLEM 8-4
Vent Molded
Plastics
Vent Molded
Plastics
Sales
Sales returns
Cost of goods sold
Selling expense
General expense
Other income
Other expense
Income tax
Net income
101.0%
7.0
72.1
9.4
7.0
.4
1.5
4.8
5.6%
100.3%
.3
67.1
10.1
7.9
.4
1.3
5.5
8.5%
Sales returns are higher than the industry. Cost of sales is much higher, offset some by lower operating expenses. Other expense (perhaps interest) is somewhat higher. Lower taxes are perhaps caused by lower income. Overall profit is less, primarily due to cost of sales.
PROBLEM 8-5
a.
2004 sales were 122.72% of those in 2003.
b.
2004 net earnings were 100.80% of those in 2003.
c. 1. Net Profit Margin =
2004 2003
2. Return on Assets =
2004 2003
3. Total Asset Turnover =
2004 2003
4. DuPont Analysis: Return on = Net Profit x Total Asset
Assets Margin Turnover
2004 10.42* = 9.39% x 1.11
2003 12.72* = 11.56% x 1.10
*Rounded causes the difference from the 10.38% and 12.67% computed in part 2.
5.
2004
2003
Operating income
Net sales
Less: Cost of product sold
Research and develop-
ment expenses
General and selling
Operating income
$1,589,150
651,390
135,314
526,680
$ 275,766
$1,294,966
466,250
113,100
446,110
$ 269,506
Operating Income Margin =
2004 2003
6. Return on Operating Assets =
2004 2003
= 19.53% = 23.24%
7. Operating Asset Turnover =
2004 2003
= 1.13 times = 1.12 times
per year per year
8. DuPont Analysis: Return on = Net Profit x Total Asset
Assets Margin Turnover
2004 19.61%* = 17.35% x 1.13
2003 23.31%* = 20.81% x 1.12
*Rounding causes the difference from the 19.53% and 23.24% computed in part 6.
9.
2004
2003
Net earnings before minority
share
Interest expense
Earnings before tax
Provision for income tax
Tax rate
1 – tax rate
(interest expense x
(1 – tax rate)
Net earnings before minority
share + (interest expense)
x (1 – tax rate)
Long-term debt + equity
Return on investment
$ 149,260
18,768
263,762
114,502
43.4%
56.6%
10,623
159,883
1,019,420
15.7%
$ 149,760
11,522
271,500
121,740
44.8%
55.2%
6,360
156,120
933,232
16.7%
10. Return on Common Equity =
2004 2003
= 17.06% = 19.03%
d. Profits in relation to sales, assets, and equity have all declined. Turnover has remained stable. Overall, although absolute profits have increased in 2004, compared with 2003, the profitability ratios show a decline.
PROBLEM 8-6
a. 1. Net Profit Margin =
2004
2003
2002
= 6.07%
= 3.96%
= 3.76%
2. Return on Assets =
2004
2003
2002
= 6.04%
= 4.21%
= 3.82%
3. Total Asset Turnover =
2004
2003
2002
= 1.11 times
per year
= 1.07 times
per year
= 1.02 times
per year
4. DuPont Analysis
Return on
Assets
=
Net Profit Margin
x
Total Asset
Turnover
2004: 6.74%
2003: 4.24%
2002: 3.84%
=
=
=
6.07%
3.96%*
3.76%*
x
x
x
1.11 times
1.07 times
1.02 times
*Rounding difference from the 4.21% and 3.82% computed in 2.
5. Operating Income Margin =
2004
2003
2002
(2) Net sales
Less:
Material and manufacturing
costs of products sold
Research and development
General and selling
(1) Operating income
(1) Dividend by (20)
$1,600,000
740,000
90,000
600,000
1,430,000
170,000
10.63%
$1,300,000
624,000
78,000
500,500
1,202,500
97,500
7.50%
$1,200,000
576,000
71,400
465,000
1,112,400
87,600
7.30%
6. Return on Operating Assets =
2004
2003
2002
Operating Income_____
Average Operating Income
$ 170,000
$1,390,200
12.23%
$ 97,500
$1,160,000
8.41%
$ 87,000
$1,090,000
7.98%
7. Operating Asset Turnover =
2004
2003
2002
Net Sales_________
Average Operating Assets
$1,600,000
$1,390,200
1.15 times
$1,300,000
$1,160,000
1.12 times
$1,200,000
$1,090,000
1.10 times
8. DuPont Analysis with operating ratios
Return on
Assets
=
Net Profit Margin
x
Total Asset
Turnover
2004: 12.22%*
2003: 8.40%*
2002: 8.03%
=
=
=
10.63%
7.50%
7.30%
x
x
x
1.15
1.12
1.10
*Rounding difference from the 12.23%, 8.41%, and 8.04% computed in 6.
9.
Estimated tax rate:
2004
2003
2002
(1) Provision for income taxes
(2) Earnings before income taxes
and Minority equity
(1) divided by (2)
1 – tax rate
(3) Interest expense x (1-tax rate)
$19,000 x 6.00%
$18,200 x 59.00%
$17,040 x 58.00%
(4) Earnings before minority equity
(3) plus (4) (A)
(5) Total long-term debt
(6) Total stockholders’ equity
(5) plus (6) (B)
(A) divided by (B)
$ 62,049
$ 159,100
39.00%
61.00%
11,590
97,051
108,641
211,100
811,200
1,022,300
10.63%
$ 35,731
$ 87,150
41.00%
59.00%
10,738
51,419
62,157
212,800
790,100
1,002,900
6.20%
$ 32,659
$ 77,760
42.00%
58.00%
9,883
45,101
54,984
214,000
770,000
984,000
5.59%
10.
2004
2003
2002
Net income etc.
Average total equity
$ 86,851
$811,200
$ 42,919
$790,100
$ 37,001
$770,000
b. All ratios computed indicate a significant improvement I profitability.
PROBLEM 8-7
a. 1.
2004
2003
2002
$ 171,115
$1,002,100
= 17.08%
$163,497
$980,500
= 16.67%
$143,990
$900,000
= 16.00%
2.
2004
2003
2002
$171,115
$839,000
= 20.40%
$163,497
$770,000
= 21.23%
$143,990
$765,000
= 18.82%
3.
2004
2003
2002
$1,002,100
$ 839,000
= 1.19 times
per year
$980,500
$770,000
= 1.27 times
per year
$900,000
$$765,000
= 1.18 times
per year
4. DuPont Analysis
Return on
Assets
=
Operating Income
Margin
x
Total Asset
Turnover
2004: 20.88%*
2003: 21.17%*
2002: 18.88%*
=
=
=
17.08%
16.67%
16.00%
x
x
x
1.19 times per year
1.27 times per year
1.18 times per year
*Rounding difference from the 20.40%, 21.23%, and 18.82% computed in 2.
5.
Estimated tax rate:
2004
2003
2002
(1) Provision for income taxes
(2) Earnings before income taxes
tax rate [(1) divided by (2)]
1 – tax rate
(3) Interest expense x (1-tax rate)
$14,620 x 59.50%
$12,100 x 59.00%
$11,250 x 57.70%
(4) Net earnings
(3) plus (4) (A)
(5) Average long-term debt
(6) Average shareholders’ equity
(5) plus (6) (B)
(A) divided by (B)
$116,473
$287,588
40.50%
59.50%
8,699
171,115
179,814
120,000
406,000
526,000
34.19%
$113,616
$277,113
41.00%
59.00%
7,139
163,497
170,636
112,000
369,500
481,500
35.44%
$105,560
$249,550
42.30%
57.70%
6,491
143,990
150,481
101,000
342,000
443,000
33.97%
6.
2004
2003
2002
Net earnings
Average total equity
$171,115
$406,000
$163,497
$369,500
$143,990
$342,000
7.
2004
2003
2002
$1,002,100
$ 302,500
= 3.31
$980,500
$281,000
= 3.49
$900,000
$173,000
= 5.20
b. The ratios computed indicate a very profitable firm. Most ratios indicate A very slight reduction in profitability in 2003.
Sales to fixed assets has declined materially, but this is the only ratio for which the trend appears to be negative.
PROBLEM 8-8
a. 1.
2004
2003
2002
$20,070-$8,028
$297,580
= 4.05%
$16,660-$6,830
$256,360
= 3.83%
$15,380-$6,229
$242,150
= 3.78%
2.
2004
2003
2002
$20,070-$8,028
$145,760
= 8.26%
$16,660-$6,830
$137,000
= 7.18%
$15,380-$6,229
$136,000
= 6.73%
3.
2004
2003
2002
$297,580
$145,760
= 2.04 times
per year
$256,360
$137,000
= 1.87 times
per year
$242,150
$136,000
= 1.78 times
per year
4. DuPont Analysis
Return on
Assets
=
Operating Income
Margin
x
Total Asset
Turnover
2004: 8.26%
2003: 7.16%*
2002: 6.73%
=
=
=
4.05%
3.83%
3.78%
x
x
x
2.04 times
1.87 times
1.78 times
*Rounding difference from the 7.18% computed in 2.
5.
2004
2003
2002
$ 26,380
$297,580
= 8.86%
$ 22,860
$256,360
= 8.92%
$ 20,180
$242,150
= 8.33%
6.
2004
2003
2002
$26,380 _____
$89,800+$45,850
= 19.45%
$ 22,860____
$84,500+$40,300
= 28.32%
$ 20,180____
$83,100+$39,800
= 16.42%
7.
2004
2003
2002
= 2.19 times
per year
= 2.05 times
per year
= 1.97 times
per year
8. DuPont Analysis with Operating Ratios
Return on
Assets
=
Operating Income
Margin
x
Total Asset
Turnover
2004: 19.40%*
2003: 18.29%*
2002: 16.41%*
=
=
=
8.86%
8.92%
8.33%
x
x
x
2.19 times
2.05 times
1.97 times
*Rounding difference from the 19.45%, 18.32%, and 16.42% computed in 6.
9.
2004
2003
2002
$ 91,580
$297,580
= 30.77%
$ 80,060
$256,360
= 31.23%
$ 76,180
$242,150
= 31.46%
b. Net profit margin and total asset turnover both improved. This resulted in a substantial improvement to return on assets.
Operating income margin declined slightly in 2003 after a substantial improvement in 2002. Operating asset turnover improved each year. The result of the improvement in operating income margin and operating asset turnover was a substantial improvement in return on operating assets.
Gross profit margin declined slightly each year.
Overall profitability improved substantially over the three-year period.
PROBLEM 8-9
a. 1.
2004
2003
2002
(A)
(B)
$ 2,100,000
$ 2,600,000
7,000,000
100,000
10,000,000
$19,700,000
$ 1,950,000
$ 2,300,000
6,200,000
100,000
9,000,000
$17,600,000
$ 1,700,000
$ 2,200,000
5,800,000
100,000
8,300,000
$16,400,000
2.
Estimated tax rate:
2004
2003
2002
(1) Provision for income taxes
(2) Income before tax
tax rate = (1) divided by (2)
1 – tax rate
(3) Interest expense x (1-tax rate)
$80,000 x 58.33%
$600,000 x 57.35%
$550,000 x 61.82%
(4) Net income
(3) plus (4) (A)
Long-term debt
Preferred stock
Common equity
(B)
(A) divided by (B)
$ 1,500,000
3,600,000
41.67%
58.33%
$ 466,640
$ 2,100,000
$ 2,566,640
$ 7,000,000
100,000
10,000,000
$17,100,000
15.01%
$ 1,450,000
3,400,000
42.65%
57.35%
$ 344,100
$ 1,950,000
$ 2,294,100
$ 6,200,000
100,000
9,000,000
$15,300,000
14.99%
$ 1,050,000
2,750,000
38.18%
61.82%
$ 340,000
$ 1,700,000
$ 2,040,010
$ 5,800,000
100,000
8,300,000
$14,200,000
14.37%
3.
2004
2003
2002
= 20.79%
= 21.43%
= 29.24%
4.
2004
2003
2002
= 20.86%
= 21.51%
= 20.31%
b. Return on assets improved in 2003 and then declined in 2004. Return on investment improved each year. Return on total equity improved and then declined. Return on common equity improved and then declined.
In general, profitability has improved in 2003 over 2002 but was down slightly in 2004.
c. The use of long-term debt and preferred stock both benefited profitability.
Return on common equity is slightly more than return on total equity, indicating a benefit from preferred stock.
Return on total equity is substantially higher than return on investment, indicating a benefit from long-term debt.
PROBLEM 8-10
a. Sales $120,000
Gross profit (40%) 48,000
Cost of goods sold (60%) 72,000
Beginning inventory $ 10,000
+ purchase 100,000
Total available 110,000
- Ending inventory ?____
Cost of goods sold $ 72,000
Ending inventory (110,000-72,000) $ 38,000
b. If gross profit were 50%, the analysis would be as follows:
Sales $120,000
Gross profit (50%) 60,000
Cost of goods sold (50%) 60,000
Beginning inventory $ 10,000
Purchases 100,000
Total available $110,000
- Ending inventory 50,000
Cost of goods sold $ 60,000
If gross profit were higher, the loss would be higher.
PROBLEM 8-11
Net
Profit
Retained
Earnings
Total
Stockholders’
Equity
a. a stock dividend is
declared and paid.
b. Merchandise is purchased
on credit.
c. Marketable securities are
sold above cost.
d. Accounts receivable are
collected.
e. A cash dividend is
declared and paid.
f. Treasury stock is
purchased and recorded
at cost.
g. Treasury stock is sold
above cost.
h. Common stock is sold.
i. A fixed asset is sold for
less than book value.
j. Bonds are converted into
common stock.
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