3-11. Continued
c. Return on equity?Return on assets ?investment??1?Debt/Asset25.2%s???1?.35?
25.2%0.65??38.77%
3-12.
Jennifer’s Shoe Stores has $2,000,000 in yearly sales. The firm earns 3.8 percent on each dollar of sales and turns over its assets 2.5 times per year. It has $60,000 in current liabilities and $140,000 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.
Solution:
Jennifer Shoe Stores
a. Net income?Sales?profit margin?$2,000,000?3.8%
?$76,000
Copyright ? 2005 by The McGraw-Hill Companies, Inc.
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3-12. Continued
Stockholders equity?Total assets?Total liabilities Total assets?Sales/Total asset turnover
?$2,000,000/2.5?$800,000
Total liabilities?Current liabilities?Long-term liabilities?$60,000?$140,000?$200,000Stockholders' equity?$800,000?$200,000?$600,000Return on stockholders' equity?Net incomeStockholders' equity?$76,000$600,000
?12.67%S-55
Copyright ? 2005 by The McGraw-Hill Companies, Inc.
3-12. Continued
b. The Value for sales will be:
Sales?Total assets?Total asset turnover?$800,000?3
?$2,400,000
Net income?Sales?Profit margin
?$2,400,000?3.8%
?$91,200
Return on stockholders' equity?Net incomeStockholders' equity
?$91,200$600,000?15.2%
Copyright ? 2005 by The McGraw-Hill Companies, Inc.
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3-13.
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. 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.
Solution:
Interactive Technology and Silicon Software
a.
Interactive Technology (IT) Net incomeStockholders' equity?$15,000$100,000?15%Silicon Software (SS)
$50,000$160,000?31.25%
Silicon Software (SS) has a much higher return on stockholders' equity than Interactive Technology (IT).
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Copyright ? 2005 by The McGraw-Hill Companies, Inc.
3-13. Continued
b.
Interactive Technology (IT) ?$15,000$150,000$15,000$160,000$150,000$160,000$60,000$160,000?10%Silicon Software (SS)
$50,000$1,000,000$50,000$400,000$1,000,000$400,000$240,000$400,000?5%Net incomeSalesNet incomeTotal assetsSalesTotal assetsDebtTotal assets??9.37%?12.5%
??.937x?2.5x??37.5%?60%
As previously indicated, Silicon Software (SS) has a substantially higher return on stockholder's equity than Interactive Technology (IT). The reason is certainly not to be found on return on the sales dollar where Interactive Technology has a higher return than Silicon Software (10% vs. 5%).
However, Silicon Software has a higher return than Interactive Technology on total assets (12.5% versus 9.37%). The reason is clearly to be found in total asset turnover, which strongly favors Silicon Software over Interactive Technology (2.5x versus .937x). This factor alone leads to the higher return on total assets.
Copyright ? 2005 by The McGraw-Hill Companies, Inc.
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