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Chapter 2: Q7DQ_a (page 75)

Inflation can have significant effects on income statements and balance sheets, and therefore on the calculation of ratios. Discuss the possible impact of inflation on the following ratios, and explain the direction of the impact based on your assumptions.

a. Return on investment

Short Answer

Expert verified

In the case of inflation in an economy, the return on investment increases.

Step by step solution

01

Formula to compute Return on investments:

ReturnonInvestment=NetincomeaftertaxTotalassets

02

Return on investments:

The return on investment is obtained by dividing the net income after tax by the total assets.Inflation may increase the company's net income and may not affect the company's total assets. Therefore, it may lead to an increase in the return on investment.

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Most popular questions from this chapter

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

b. Compute inventory turnover based on an alternative calculation that is used by many financial analysts, Cost of goods sold/Inventory, for each year.

Comment on why inflation may restrict the usefulness of the balance sheet as normally presented.

Dr. Zhivàgo Diagnostics Corp.’s income statement for 20X1 is as follows

Sales\( 2790000
Cost of goods sold1790000
Gross profits\) 1000000
Selling and administrative expenses302000
Operating profits\( 698000
Interest Expense54800
Income before tax\) 643200
Taxes 30%192960
Income after tax$ 450240

b. Assume that in 20X2, sales increase by 10 percent and cost of goods sold increases by 20 percent. The firm is able to keep all other expenses the same. Assume a tax rate of 30 percent on income before taxes. What is income after taxes and the profit margin for 20X2?

Using the income statement for Times Mirror and Glass Co., compute the following ratios:

a. The interest coverage.

Times mirror and glass company

Sales

\(126,000

Less: Cost of goods sold

93,000

Gross profit

\)33,000

Less: selling and administrative expenses

11,000

Lease Expenses

4,000

Operating profit*

\(18,000

Less: Interest expenses

3,000

Earning before taxes

\)15,000

Less: Taxes (30%)

4,500

Earning after taxes

$10,500

*equal income before interest and taxes

If we divide users of ratios into short-term lenders, long-term lenders, andstockholders,which ratios would each group be most interested in, and for

what reasons?
See all solutions

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