Chapter 3

Problems
1. Dental Delights has two divisions. Division A has a profit of $200,000 on sales of $4,000,000.
Division B is only able to make $30,000 on sales of $480,000. Based on the profit margins (returns
on sales), which division is superior?

2. Griffey Junior Wear, Inc., has $800,000 in assets and $200,000 of debt. It reports net income of
$100,000.
a. What is the return on assets?
b. What is the return on stockholders’ equity?

3. Bass Chemical, Inc., is considering expanding into a new product line. Assets to support this
expansion will cost $1,200,000. Bass estimates that it can generate $2 million in annual sales, with a 5
percent profit margin. What would net income and return on assets (investment) be for the year?

4. Franklin Mint and Candy Shop can open a new store that will do an annual sales volume of
$750,000. It will turn over its assets 2.5 times per year. The profit margin on sales will be
6 percent. What would net income and return on assets (investment) be for the year?

5. Hugh Snore Bedding, Inc., has assets of $400,000 and turns over its assets 1.5 times per year.
Return on assets is 12 percent. What is its profit margin (return on sales)?

6. One-Size-Fits-All Casket Co.’s income statement for 2008 is as Follows:

Sales .......................................................................................$3,000,000
Cost of goods sold.................................................................. 2,100,000
Gross profit ............................................................................ 900,000
Selling and administrative expense ........................................ 450,000
Operating profit ...................................................................... 450,000
Interest expense ...................................................................... 75,000
Income before taxes ............................................................... 375,000
Taxes (30%) ........................................................................... 112,500
Income after taxes .................................................................. $262,500

a. Compute the profit margin for 2008.

b. Assume in 2009, sales increase by 10 percent and cost of goods sold increases by 25%. The
firm is able to keep all other expenses the same. Once again, assume a tax rate of 30 percent on
income before taxes. What are income after taxes and the profit margin for 2009?
7. Easter Egg and Poultry Company has $2,000,000 in assets and $1,400,000 of debt. It reports net
income of $200,000.
a. What is the firm’s return on assets?
b. What is its return on stockholders’ equity?
c. If the firm has an asset turnover ratio of 2.5 times, what is the profit margin
(return on sales)?

8. Sharpe Razor Company has total assets of $2,500,000 and current assets of $1,000,000. It turns
over its fixed assets 5 times a year and has $700,000 of debt. Its return on sales is
3 percent. What is Sharpe’s return on stockholders’ equity?

9. Baker Oats had an asset turnover of 1.6 times per year.

a. If the return on total assets (investment) was 11.2 percent, what was Baker’s profit margin?
b. The following year, on the same level of assets, Baker’s assets turnover declined to 1.4 times
and its profit margin was 8 percent. How did the return on total assets change from that of the
previous year?
10. Global Healthcare Products has the following ratios compared to its industry for 2008.

Global
Healthcare Industry
Return on sales……….. 2% 10%
Return on assets……… 18% 12%

Explain why the return-on-assets ratio is so much more favorable than the return-on-sales ratio
compared to the industry. No numbers are necessary; a one-sentence answer is all that is required.
11. Acme Transportation Company has the following ratios compared to its industry
for 2009.

Acme
Transportation Industry
Return on assets…………… 9% 6%
Return on equity…………… 12% 24%

Explain why the return-on-equity ratio is so much less favorable than the return-on-assets ratio
compared to the industry. No numbers are necessary; a one-sentence answer is all that is required.

12. Gates Appliances has a return-on-assets (investment) ratio of 8 percent.

a. If the debt-to-total-assets ratio is 40 percent, what is the return on equity?
b. If the firm had no debt, what would the return-on-equity ratio be?

13. Using the Du Pont method, evaluate the effects of the following relationships for the Butters
Corporation.
a. Butters Corporation has a profit margin of 7 percent and its return on assets (investment) is 25.2
percent. What is its assets turnover?
 b. If the Butters Corporation has a debt-to-total-assets ratio of 50 percent, what would the firm’s
return on equity be?
c. What would happen to return on equity if the debt-to-total-assets ratio decreased to
35 percent?

14. Jerry Rice and Grain Stores has $4,000,000 in yearly sales. The firm earns 3.5 percent on each
dollar of sales and turns over its assets 2.5 times per year. It has $100,000 in current liabilities and
$300,000 in long-term liabilities.
a. What is its return on stockholders’ equity?
b. If the asset base remains the same as computed in part a, but total asset turnover goes up to 3,
what will be the new return on stockholders’ equity? Assume that the profit margin stays the
same as do current and long-term liabilities.

15. Assume the following data for Interactive Technology and Silicon Software.

Interactive Silicon
Technology (IT) Software (SS)
Net income………………….. $ 15,000 $ 50,000
Sales………………………… 150,000 1,000,000
Total assets………………….. 160,000 400,000
Total debt……………………. 60,000 240,000
Stockholders’ equity…………. 100,000 160,000

a. Compute return on stockholders’ equity for both firms using ratio 3a in the text on page. Which
firm has the higher return?
b. Compute the following additional ratios for both firms.
Net income/Sales
Net income/Total assets
Sales/Total assets
Debt/Total assets
c. Discuss the factors from part b that added or detracted from one firm having a higher return on
stockholders’ equity than the other firm as computed in part a.

16. A firm has sales of $3 million, and 10 percent of the sales are for cash. The year-end accounts
receivable balance is $285,000. What is the average collection period?
(Use a 360-day year.)

17. Martin Electronics has an accounts receivable turnover equal to 15 times. If accounts receivable are
equal to $80,000, what is the value for average daily credit sales?
18. Perez Corporation has the following financial data for the years 2007 and 2008:

2007 2008
Sales………………………… $8,000,000 $10,000,000
Cost of goods sold…………… 6,000,000 9,000,000
Inventory…………………….. 800,000 1,000,000

a. Compute inventory turnover based on ratio number 6, Sales/Inventory, for each year.
b. Compute inventory turnover based on an alternative calculation that is used by many financial
analysts, Cost of goods sold/Inventory, for each year.
c. What conclusions can you draw from part a and part b?

19. The Speed-O Company makes scooters for kids. Sales in 2008 were $8,000,000. Assets were as
follows:

Cash………………………………………. $200,000
Accounts receivable………………………. 1,600,000
Inventory………………………………….. 800,000
Net plant and equipment………………….. 1,000,000
Total assets…………………………… $3,600,000

a. Compute the following:

1. Accounts receivable turnover
2. Inventory turnover
3. Fixed asset turnover
4. Total asset turnover
b. In 2009, sales increased to $10,000,000 and the assets for that year were as follows:

Cash………………………………………... $200,000
Accounts receivable……………………….. 1,800,000
Inventory…………………………………... 2,200,000
Net plant and equipment…………………... 1,050,000
Total assets…………………………….. $5,250,000

Once again, compute the four ratios.

c. Indicate if there is an improvement or decline in total asset turnover, and based on the other
ratios, indicate why this development has taken place
20. The balance sheet for Stud Clothiers is shown below. Sales for the year were $2,400,000, with
90 percent of sales sold on credit.
 STUD CLOTHIERS
Balance Sheet 200X
Assets Liabilities and Equity
Cash…………………… $ 60,000 Accounts payable…………….. $ 220,000
Accounts receivable…... 240,000 Accrued taxes………………… 30,000
Inventory……………… 350,000 Bonds payable 150,000
(long-term)……………………
Plant and equipment…... 410,000 Common stock……………….. 80,000
Paid-in capital………………… 200,000
Retained earnings…………….. 380,000
Total assets………... $1,060,000 Total liabilities and equity… $1,060,000

Compute the following ratios:

a. Current ratio.
b. Quick ratio.
c. Debt-to-total-assets ratio.
d. Asset turnover.
e. Average collection period.

21. Neeley Office Supplies income statement is given below.

a. What is the times interest earned ratio?
b. What would be the fixed charge coverage ratio?

NEELEY OFFICE SUPPLIES

Sales .............................................................................. $200,000
Cost of goods sold......................................................... 115,000
Gross profit ................................................................... 85,000
Fixed charges (other than interest) ................................ 25,000
Income before interest and taxes................................... 60,000
Interest........................................................................... 15,000
Income before taxes ...................................................... 45,000
Taxes ............................................................................. 15,300
Income after taxes ......................................................... $ 29,700

22. Using the income statement for times Mirror and Glass Co., compute the following ratios:
a. The interest coverage.
b. The fixed charge coverage.
The total assets for this company equal $80,000. Set up the equation for the Du Pont system of ratio
analysis, and compute c, d, and e.
c. Profit margin.
d. Total asset turnover.
e. Return on assets (investment).
 PASTE MANAGEMENT COMPANY
Sales .............................................................................. $126,000
Less: Cost of goods sold ............................................... 93,000
Gross profit ................................................................... 33,000
Less: Selling and administrative expense ..................... 11,000
Less: Lease expense ...................................................... 4,000
Operating profit* ........................................................... $ 18,000
Less: Interest expense ................................................... 3,000
Earnings before taxes .................................................... $ 15,000
Less: Taxes (30%)......................................................... 4,500
Earnings after taxes ....................................................... $ 10,500
*Equals income before interest and taxes.

23. A firm has net income before interest and taxes of $120,000 and interest expense of $24,000.
a. What is the times interest earned ratio?
b. If the firm’s lease payments are $40,000, what is the fixed charge coverage?

24. In January 1999, the Status Quo Company was formed. Total assets were $500,000, of which
$300,000 consisted of depreciable fixed assets. Status Quo uses straight-line depreciation, and in
1999 it estimated its fixed assets to have useful lives of 10 years. Aftertax income has been $26,000
per year each of the last 10 years. Other assets have not changed since 1999.
a. Compute return on assets at year-end for 1999, 2001, 2004, 2006, and 2008.
(Use $26,000 in the numerator for each year.)
b. To what do you attribute the phenomenon shown in part a?
c. Now assume income increased by 10 percent each year. What effect would this have on your
above answers? Merely comment.

25. Calloway Products has the following data. Industry information is also shown:

Industry Data on Net Year

Net Income Total Assets Income/Total Assets
2006 $360,000 $3,000,000 11%
2007 380,000 3,400,000 8
2008 380,000 3,800,000 5
Industry Data on
Year Debt Total Assets Debt/Total Assets
2006 $1,600,000 $3,000,000 52%
2007 1,750,000 3,400,000 40
2008 1,900,000 3,800,000 31

As an industry analyst comparing the firm to the industry, are you likely to praise or criticize the
firm in terms of:
a. Net income/Total assets?
b. Debt/Total assets?
26. Jodie Foster Care Homes, Inc., shows the following data:

Year Net Income Total Assets Stockholders’ Equity Total Debt

2005 $118,000 $1,900,000 $ 700,000 $1,200,000
2006 131,000 1,950,000 950,000 1,000,000
2007 148,000 2,010,000 1,100,000 910,000
2008 175,700 2,050,000 1,420,000 630,000

a. Compute the ratio of net income to total assets for each year and comment on the trend.
b. Compute the ratio of net income to stockholders’ equity and comment on the trend. Explain
why there may be a difference in the trends between parts a and b.

27. The United World Corporation has three subsidiaries.

Computers Magazines Cable TV

Sales ....................................... $16,000,000 $4,000,000 $8,000,000
Net income (after taxes) ......... 1,000,000 160,000 600,000
Assets ..................................... 5,000,000 2,000,000 5,000,000
.

a. Which division has the lowest return on sales?

b. Which division has the highest return on assets?
c. Compute the return on assets for the entire corporation.
d. If the $5,000,000 investment in the cable TV division is sold off and redeployed in the
computer division at the same rate of return on assets currently achieved in the computer
division, what will be the new return on assets for the entire corporation?

28. Omni Technology Holding Company has the following three affiliates:

Personal Foreign
Software Computers Operations
Sales ................................. $40,000,000 $60,000,000 $100,000,000
Net income (after taxes) ... 2,000,000 2,000,000 8,000,000
Assets ............................... 5,000,000 25,000,000 60,000,000
Stockholders’ equity ........ 4,000,000 10,000,000 50,000,000

a. Which affiliate has the highest return on sales?

b. Which affiliate has the lowest return on assets?
c. Which affiliate has the highest total asset turnover?
d. Which affiliate has the highest return on stockholders’ equity?
e. Which affiliate has the highest debt ratio? (Assets minus stockholders’ equity equals debt.)
f. Returning to question b, explain why the software affiliate has the highest return on total
assets.
g. Returning to question d, explain why the personal computer affiliate has a higher return on
stockholders’ equity than the foreign operations affiliate even though it has a lower return on
total assets.
29. Bard Corporation shows the following income statement. The firm uses FIFO inventory accounting.

BARD CORPORATION
Income Statement for 2008
Sales ..................................................................... $200,000 (10,000 units at $20)
Cost of goods sold................................................ 100,000 (10,000 units at $10)
Gross profit .......................................................... 100,000
Selling and administrative expense ...................... 10,000
Depreciation ......................................................... 20,000
Operating profit .................................................... 70,000
Taxes (30%) ......................................................... 21,000
Aftertax income ................................................... $ 49,000

a. Assume in 2009 the same 10,000-unit volume is maintained, but that the sales price increases
by 10 percent. Because of FIFO inventory policy, old inventory will still be charged off at $10
per unit. Also assume that selling and administrative expense will be 5 percent of sales and
depreciation will be unchanged. The tax rate is 30 percent. Compute aftertax income for 2009.
b. In part a, by what percent did aftertax income increase as a result of a 10 percent increase in
the sales price? Explain why this impact occurred.
c. Now assume that in 2010 the volume remains constant at 10,000 units, but the sales price
decreases by 15 percent from its year 2009 level. Also, because of FIFO inventory policy, cost
of goods sold reflects the inflationary conditions of the prior year and is $11 per unit. Further,
assume selling and administrative expense will be 5 percent of sales and depreciation will be
unchanged. The tax rate is 30 percent. Compute the aftertax income.

30. Construct the current assets section of the balance sheet from the following data. (Use cash as a
plug figure after computing the other values.)

Yearly sales (credit) ..................................................................... $720,000

Inventory turnover ....................................................................... 6 times
Current liabilities ......................................................................... $105,000
Current ratio ................................................................................. 2
Average collection period ............................................................ 35 days
Current assets:
Cash......................................................................... $______
Accounts receivable ................................................ ______
Inventory ................................................................. ______
Total current assets .............................................. ______

31. The Griggs Corporation has credit sales of $1,200,000. Given the following ratios, fill in the
balance sheet below.

Total assets turnover ................................... 2.4 times

Cash to total assets ...................................... 2.0%
Accounts receivable turnover ..................... 8.0 times
Inventory turnover ...................................... 10.0 times
Current ratio ................................................ 2.0 times
Debt to total assets ...................................... 61.0%
 GRIGGS CORPORATION
Balance Sheet 2008
Assets Liabilities and Stockholders’ Equity
Cash .............................. _____ Current debt ............................................. _____
Accounts receivable ...... _____ Long-term debt......................................... _____
Inventory ....................... _____ Total debt ........................................... _____
Total current assets _____ Equity ....................................................... _____
Fixed assets .................. _____ Total debt and stockholders’ equity _____
Total assets ............. _____

32. We are given the following information for the Coleman Machine Tools Corporation.

Sales (credit) ....................................................................... $7,200,000

Cash..................................................................................... 300,000
Inventory ............................................................................. 2,150,000
Current liabilities ................................................................ 1,400,000
Asset turnover ..................................................................... 1.20 times
Current ratio ........................................................................ 2.50 times
Debt-to-assets ratio ............................................................. 40%
Receivables turnover ........................................................... 8 times

Current assets are composed of cash, marketable securities, accounts receivable, and inventory.
Calculate the following balance sheet items.
a. Accounts receivable.
b. Marketable securities.
c. Fixed assets.
d. Long-term debt.

33. The following data are from Sharon Stone and Gravel, Inc., financial statements. The firm
manufactures home decorative material. Sales (all credit) were $60 million for 2008.

Sales to total assets......................................... 3.0 times

Total debt to total assets ................................. 40%
Current ratio ................................................... 2.0 times
Inventory turnover ......................................... 10.0 times
Average collection period .............................. 18.0 days
Fixed asset turnover ....................................... 7.5 times

Fill in the balance sheet:

Cash..................................... ______ Current debt .......................................... ______

Accounts receivable ............ ______ Long-term debt...................................... ______
Inventory ............................. ______ Total debt ........................................ ______
Total current assets ....... ______ Equity .................................................... ______
Fixed assets ......................... ______ Total debt and stockholders’ equity ______
Total assets .................... ______
34. Using the financial statements for the Goodyear Calendar Company, calculate the 13 basic ratios
found in the chapter.

GOODYEAR CALENDAR COMPANY

Balance Sheet
December 31, 2008
Assets
Current assets:
Cash............................................................................................... $ 40,000
Marketable securities .................................................................... 30,000
Accounts receivable (net) ............................................................. 120,000
Inventory ....................................................................................... 180,000
Total current assets .................................................................... $370,000
Investments ....................................................................................... 40,000
Plant and equipment .......................................................................... 450,000
Less: Accumulated depreciation ................................................... (100,000)
Net plant and equipment ............................................................ 350,000
Total assets ........................................................................................ $760,000

GOODYEAR CALENDAR COMPANY

Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable .......................................................................... $ 90,000
Notes payable ................................................................................ 10,000
Accrued taxes ................................................................................ 10,000
Total current liabilities ............................................................... 110,000
Long-term liabilities:
Bonds payable ............................................................................... 170,000
Total liabilities ........................................................................... 280,000
Stockholders’ equity..........................................................................
Preferred stock, $100 par value .................................................... 90,000
Common stock, $1 par value ........................................................ 60,000
Capital paid in excess of par ......................................................... 230,000
Retained earnings .......................................................................... 100,000
Total stockholders’ equity.......................................................... 480,000
Total liabilities and stockholders’ equity .......................................... $760,000
 GOODYEAR CALENDAR COMPANY
Income Statement
For the Year Ending December 31, 2008
Sales (on credit)................................................................................. $2,000,000
Less: Cost of goods sold ............................................................... 1,300,000
Gross profit ....................................................................................... 700,000
Less: Selling and administrative expenses .................................... 400,000*
Operating profit (EBIT) .................................................................... 300,000
Less: Interest expense ................................................................... 20,000
Earnings before taxes (EBT) ............................................................. 280,000
Less: Taxes.................................................................................... 112,000
Earnings after taxes (EAT)................................................................ $ 168,000
*Includes $10,000 in lease payments.

35. Given the financial statements for Jones Corporation and Smith Corporation:
a. To which company would you, as credit manager for a supplier, approve the extension of
(short-term) trade credit? Why? Compute all ratios before answering.
b. In which one would you buy stock? Why?

JONES CORPORATION
Current Assets Liabilities
Cash ............................... $ 20,000 Accounts payable ................... $100,000
Accounts receivable ....... 80,000 Bonds payable (long-term)..... 80,000
Inventory ........................ 50,000
Long-Term Assets Stockholders’ Equity
Fixed assets .................... $500,000 Common stock ....................... $150,000
Less: Accumulated Paid-in capital ........................ 70,000
depreciation ............. (150,000) Retained earnings ................... 100,000
*Net fixed assets ........ 350,000 Total liabilities and equity $500,000
Total assets .............. $500,000

Sales (on credit).......................................................................................

$1,250,000
Cost of goods sold ...................................................................................
750,000
Gross profit .............................................................................................
500,000
†Selling and administrative expense .................................................... 257,000
Less: Depreciation expense .................................................................. 50,000
Operating profit .......................................................................................
193,000
Interest expense .......................................................................................
8,000
Earnings before taxes ..............................................................................
185,000
Tax expense.............................................................................................
92,500
Net income ..............................................................................................
$ 92,500
*Use net fixed assets in computing fixed asset turnover.
†Includes $7,000 in lease payments.
 SMITH CORPORATION
Current Assets Liabilities
Cash ................................. $ 35,000 Accounts payable .................. $ 75,000
Marketable securities ...... 7,500 Bonds payable (long-term) .... 210,000
Accounts receivable ........ 70,000
Inventory ......................... 75,000
Long-Term Assets Stockholders’ Equity
Fixed assets ..................... $500,000 Common stock....................... $ 75,000
Less: Accumulated Paid-in capital ........................ 30,000
depreciation ................ (250,000) Retained earnings .................. 47,500
*Net fixed assets ........... 250,000 Total liabilities and equity ... $437,500
Total assets ................. $437,500

Sales (on credit) .......................................................... $1,000,000

Cost of goods sold ...................................................... 600,000
Gross profit ................................................................. 400,000
†Selling and administrative expense ...................... 224,000
Less: Depreciation expense .................................... 50,000
Operating profit .......................................................... 126,000
Interest expense .......................................................... 21,000
Earnings before taxes .................................................. 105,000
Tax expense ................................................................ 52,500
Net income .................................................................. $ 52,500
*Use net fixed assets in computing fixed asset turnover.
†Includes $7,000 in lease payments.