3-6. Continued
Net income = Sales x profit margin = $7,500,000 x 3% = $225,000
Return on stockholders' equity?Net incomeStockholders' equity
? 3-7.
$225,000$1,800,000?12.5%
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 asset 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?
Solution:
Baker Oats
a. Total asset turnover ? Profit Margin = Return on Total assets
1.6???11.2%
Profit margin?11.2%1.6?7.0%
b. 1.4 ? 8%?11.2%
It did not change at all because the increase in profit margin made up for the decrease in the asset turnover.
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Copyright ? 2005 by The McGraw-Hill Companies, Inc.
3-8.
Global Healthcare Products has the following ratios compared to its industry for 2004. 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.
Solution:
Global Healthcare Products
Global Healthcare Products has a higher asset turnover ratio than the industry.
Return on AssetsReturn on Sales?Asset Turnover18%2%vs12%
9?vs 1.2?
Copyright ? 2005 by The McGraw-Hill Companies, Inc.
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3-9.
Acme Transportation Company has the following ratios compared to its industry for 2005. 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.
Solution:
Acme Transportation Company
Acme Transportation has a lower debt/total assets ratio than the industry.
For those who did a calculation, Acme’s debt to assets were 25% vs 75% for the industry.
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Copyright ? 2005 by The McGraw-Hill Companies, Inc.
3-10.
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?
Solution:
Gates Appliances
a.
Return on equity?Return on assets ?investment??1?Debt/Asset8%s???1?0.40?
8%0.60??13.33%
b. The same as return on assets (8%).
Copyright ? 2005 by The McGraw-Hill Companies, Inc.
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3-11.
Using the Du Pont method, please 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 asset turnover ratio?
b. If the Butters Corporation has a debt-to-total-assets ratio of 50 percent, what
will 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?
Solution:
Butters Corporation
a.Profit margin?Total asset turnover??25.2% ?25.2%7%Return on asset ?investment7%???Total asset turnover?3.6x b.
Return on equity?Return on assets ?investment??1?Debt/Asset25.2%s???1?0.50?
25.2%0.50??50.40%
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Copyright ? 2005 by The McGraw-Hill Companies, Inc.