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Chapter 2: 26BP_b (page 83)

In January 2007, the Status Quo Company was formed. Total assets were \(544,000, of which \)306,000 consisted of depreciable fixed assets. Status

Quo uses straight-line depreciation of \(30,600 per year, and in 2007 it estimated its fixed assets to have useful lives of 10 years. Aftertax income has been \)29,000 per year each of the last 10 years. Other assets have not changed since 2007.

b. To what do you attribute the phenomenon shown in part a?

Short Answer

Expert verified

The increasing return on assets over time is solely due to annual depreciation charges. This is because the annual depreciation charges reduce the amount of investment and the net income of the company is stable.

Step by step solution

01

Return on assets

The return on total asset is computed by dividing the net income by the total assets of the company.

02

Return on assets for the year ending 2007, 2009, 2012, 2014, and 2016

The increase in annual depreciation is causing the decrease in the total assets of the company annually. As a result, the return on assets is increasing from 2007 through 2016.

Year

Net Income (a)

Total assets (b)

Return on assets (a/b)

2007

$29,000

$513,400

5.65%

2009

29,000

452,200

6.41%

2012

29,000

360,400

8.05%

2014

29,000

299,200

9.69%

2016

$29,000

$238,000

12.18%

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Most popular questions from this chapter

In 20X2, sales increased to \(5,740,000 and the assets for that year were as follows:

Cash

\)163,000

Accounts receivable

924,000

Inventory

1,063,000

New plant and equipment

520,000

Total assets

$2,670,000

Once again compute the four ratios

b. Compute the following:

1. Accounts receivable turnover.

2. Inventory turnover.

3. Fixed asset turnover.

4. Total asset turnover.

Nova Electrics anticipates cash flow from operating activities of \(6 million in 20X1. It will need to spend \)1.2 million on capital investments to remain

competitive within the industry. Common stock dividends are projected at

\(.4 million and preferred stock dividends at \).55 million.

a. What is the firm’s projected free cash flow for the year 20X1?

b. What does the concept of free cash flow represent?

Perez Corporation has the following financial data for the years 20X1 and 20X2:

20X1

20X2

Sales

\(8,000,000

\)10,000,000

Cost of goods sold

6,000,000

9,000,000

Inventory

800,000

1,000,000

c. What conclusions can you draw from part a and part b?

Lemon Auto Wholesalers had sales of \(1,000,000 last year, and cost of goods sold represented 78 percent of sales. Selling and administrative expenses were 12 percent of sales. Depreciation expense was \)11,000 and interest expense for the year was \(8,000. The firm’s tax rate is 30 percent.

a. Compute earnings after taxes.

b. Assume the firm hires Ms. Carr, an efficiency expert, as a consultant. She suggests that by increasing selling and administrative expenses to 14 percent of sales, sales can be increased to \)1,050,900. The extra sales effort will also reduce cost of goods sold to 74 percent of sales. (There will be a larger markup in prices as a result of more aggressive selling.) Depreciation expense will remain at \(11,000. However, more automobiles will have to be carried in inventory to satisfy customers, and interest expense will go up to \)15,800. The firm’s tax rate will remain at 30 percent. Compute revised earnings after taxes based on Ms. Carr’s suggestions for Lemon Auto Wholesalers. Will her ideas increase or decrease profitability?

Explain how the Du Pont system of analysis breaks down return on assets. Also explain how it breaks down return on stockholders’ equity
See all solutions

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