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Chapter 2: Question 5-6DQ (page 143)
Discuss the limitations of financial leverage.
There is always a risk of loss or failure in generating the expected return along with the burden of paying interest on debts. It may increase the financial loss of the company.
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The Lancaster Corporation’s income statement is given below.
b. What would be the fixed-charge-coverage ratio?
Lancaster corporation | |
Sales | \(246,000 |
Cost of goods sold | 122,000 |
Gross profit | \)124,000 |
Fixed charges (other than interest) | 27,500 |
Income before interest and taxes | \(96,500 |
Interest | 21,800 |
Income before taxes | \)74,700 |
Taxes (35%) | 26,145 |
Income after taxes | $48,555 |
Explain how the Du Pont system of analysis breaks down return on assets. Also explain how it breaks down return on stockholders’ equity
Using the income statement for Times Mirror and Glass Co., compute the following ratios:
The total assets for this company equal \(80,000. Set up the equation for the Du Pont system of ratio analysis, and compute c, d, and e.
c. Profit margin.
Times mirror and glass company | |
Sales | \)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
Arrange the following items in proper balance sheet presentation:
Accumulated depreciation | \(309,000 |
Retained earnings | 187,000 |
Cash | 14,000 |
Bonds payable | 136,000 |
Accounts receivable | 54,000 |
Plant and equipment – original cost | 775,000 |
Accounts payable | 35,000 |
Allowance for bad debts | 9,000 |
Common stock, \)1 par, 100,000 share outstanding | 100,000 |
Inventory | 70,000 |
Preferred stock, $59 par, 1,000 share outstanding | 59,000 |
Marketable securities | 24,000 |
Investments | 20,000 |
Notes payable | 34,000 |
Capital paid in excess of par (common stock) | 88,000 |
What advantage does the fixed charge coverage ratio offer over simply using times interest earned?
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