From the balance sheet: Cash....................................................

Question

From the balance sheet:    Cash.............................................................$       30,000    Accountsreceivable.......................................         150,000    Inventory.......................................................         200,000    Plant assets(net of acc.deprec.).....................         500,000    Currentliabilities............................................          150,000    Total stockholdersequity.................................        300,000    Totalassets.....................................................      1,000,000 From the income statement:    netsales.............................................................. $ 1,500,000    Cost of goodssold.................................................  1,080,000    Operatingexpenses................................................     315,000    interestexpense.........................................................    84,000    income taxexpense....................................................      6,000    Netincome.............................................................       15,000 From the statement of cash flows:    Net cash provided byoperating...............................      $ 40,000 (including interest paid of $79,000)    net cash used in investingactivities.............................        (46,000)    Financing activities:       Amountsborrowed..............................$ 50,000       repayment of amountsborrowed............ (14,000)       Dividendspaid........................................(20,000)          Net cashprovided by financing activities.......................16,000    Net increase in cash during theyear.................................... $10,000 Computethe ratios for: returnon assets and return on equity, assuming the year end amountsrepresent the average throughout the year. Why are thereturms on assets and returns on equity so different? From the balance sheet:    Cash.............................................................$       30,000    Accountsreceivable.......................................         150,000    Inventory.......................................................         200,000    Plant assets(net of acc.deprec.).....................         500,000    Currentliabilities............................................          150,000    Total stockholdersequity.................................        300,000    Totalassets.....................................................      1,000,000 From the income statement:    netsales.............................................................. $ 1,500,000    Cost of goodssold.................................................  1,080,000    Operatingexpenses................................................     315,000    interestexpense.........................................................    84,000    income taxexpense....................................................      6,000    Netincome.............................................................       15,000 From the statement of cash flows:    Net cash provided byoperating...............................      $ 40,000 (including interest paid of $79,000)    net cash used in investingactivities.............................        (46,000)    Financing activities:       Amountsborrowed..............................$ 50,000       repayment of amountsborrowed............ (14,000)       Dividendspaid........................................(20,000)          Net cashprovided by financing activities.......................16,000    Net increase in cash during theyear.................................... $10,000 Computethe ratios for: returnon assets and return on equity, assuming the year end amountsrepresent the average throughout the year. Why are thereturms on assets and returns on equity so different? From the balance sheet:    Cash.............................................................$       30,000    Accountsreceivable.......................................         150,000    Inventory.......................................................         200,000    Plant assets(net of acc.deprec.).....................         500,000    Currentliabilities............................................          150,000    Total stockholdersequity.................................        300,000    Totalassets.....................................................      1,000,000 From the income statement:    netsales.............................................................. $ 1,500,000    Cost of goodssold.................................................  1,080,000    Operatingexpenses................................................     315,000    interestexpense.........................................................    84,000    income taxexpense....................................................      6,000    Netincome.............................................................       15,000 From the statement of cash flows:    Net cash provided byoperating...............................      $ 40,000 (including interest paid of $79,000)    net cash used in investingactivities.............................        (46,000)    Financing activities:       Amountsborrowed..............................$ 50,000       repayment of amountsborrowed............ (14,000)       Dividendspaid........................................(20,000)          Net cashprovided by financing activities.......................16,000    Net increase in cash during theyear.................................... $10,000 From the balance sheet:    Cash.............................................................$       30,000    Accountsreceivable.......................................         150,000    Inventory.......................................................         200,000    Plant assets(net of acc.deprec.).....................         500,000    Currentliabilities............................................          150,000    Total stockholdersequity.................................        300,000    Totalassets.....................................................      1,000,000 From the income statement:    netsales.............................................................. $ 1,500,000    Cost of goodssold.................................................  1,080,000    Operatingexpenses................................................     315,000    interestexpense.........................................................    84,000    income taxexpense....................................................      6,000    Netincome.............................................................       15,000 From the statement of cash flows:    Net cash provided byoperating...............................      $ 40,000 (including interest paid of $79,000)    net cash used in investingactivities.............................        (46,000)    Financing activities:       Amountsborrowed..............................$ 50,000       repayment of amountsborrowed............ (14,000)       Dividendspaid........................................(20,000)          Net cashprovided by financing activities.......................16,000    Net increase in cash during theyear.................................... $10,000 Computethe ratios for: returnon assets and return on equity, assuming the year end amountsrepresent the average throughout the year. Why are thereturms on assets and returns on equity so different?

Explanation / Answer

(1)   Return onAssets:

Operating Income:

  

   NetSales                                         $1,500,000

   Less: Cost of goodssold                $1,080,000

           Operatingexpenses                   $315,000

                                                           ---------------

Operating Income                               $105,000

                                                           -----------------

Return on Assets = [Operating Income / Total Assets]

Return on Assets = [$105,000 /$1,000,000]                         

(2)   Return onEquity:

NetIncome                                                    $150,000

Total Stockholder’s equity                            $300,000

Return on Equity = [Net Income / Total Stockholder’sequity]

Return on Equity = [$150,000 / $300,000]

The 10.5% return on assets is adequate by traditionalstandards. However, the 5% return on equity is very low. The problem arises because of Rentsch, Inc.’srelatively large interest expenses, which is stated as $84,000 forthe year.

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