140

SU 3: Profitability Analysis and Analytical Issues

QUESTIONS
3.1 Profitability Ratios
Questions 1 and 2 are based on the following information. The financial statements for Dividendosaurus, Inc., for the current year are as follows:
Balance Sheet
Cash
Accounts receivable
Inventory
Net fixed assets
Total

$100
200
50
600
$950

Accounts payable
Long-term debt
Capital stock
Retained earnings
Total

$140
300
260
250
$950

1. Dividendosaurus has return on assets of
A. 21.1%
B. 39.2%
C. 42.1%
D. 45.3%

2. Dividendosaurus has a profit margin of
A. 6.67%
B. 13.33%
C. 14.33%
D. 46.67%
3. In the current year, Griffin Inc. had $15 million in sales, while total fixed costs were held to $6 million.
The firm’s total assets at year-end were $20 million and the debt/equity ratio was calculated at 0.60. If the firm’s EBIT is $3 million, the interest on all debt is 9%, and the tax rate is 40%, what is the firm’s return on equity? A. 11.16%
B. 14.4%
C. 18.6%
D. 24.0%

4. White Knight Enterprises is experiencing a growth rate of 9% with a return on assets of 12%. If the debt ratio is 36% and the market price of the stock is $38 per share, what is the return on equity?
A. 7.68%
B. 9.0%
C. 12.0%
D. 18.75%

Statement of Income and Retained Earnings
Sales
$ 3,000
Cost of goods sold
(1,600)
Gross profit
$ 1,400
Operations expenses
(970)
Operating income
$ 430
Interest expense
(30)
Income before tax
$ 400
Income tax
(200)
Net income
$ 200
Plus Jan. 1 retained earnings
150
Minus dividends
(100)
Dec. 31 retained earnings
$ 250
Answer (A) is correct. (CIA, adapted)
REQUIRED: The return on assets.
DISCUSSION: The return on assets is the ratio of net income to total assets. It equals 21.1% ($200 NI ÷ $950 total assets). Answer (B) is incorrect. The ratio of net income to common equity is 39.2%. Answer (C) is incorrect. The ratio of income before tax to total assets is 42.1%. Answer (D) is