A comapny has a net profit margin of 4 percent and earnings after taxes of $200
ID: 2650864 • Letter: A
Question
A comapny has a net profit margin of 4 percent and earnings after taxes of $200 million. it's current balance sheet is as follows:
Current assets $ 6,000,000,000 current liabilities $ 3,500,000,000
fixed assets $ 10,000,000,000 long term debt $ 8,500,000,000
total assets $ 16,000,000,000 common stock $ 2,000,000,000
Retained Earnings $ 2,000,000,000
total stock holder equity $ 16,000,000,000
(A) Calculate the company return on stockholders equity
(B) Industry average ratios are:
Net profit margin 5%
Total asset turnover 1.6 times
Equity multiplier 1.2 times
Calculate the company ratios: net profit margin, total asset turnover and Equity multiplier, then compare them with the averages of the industry. what do they indicate about the company's strengths and weaknesses?
Explanation / Answer
(a) Return on Equity = Net Income/(common stock+retained earnings)
net income = $200 million
common stock+retained earnings = 2,000 million+2,000 million = 4,000 million
ROE = 200/4,000 = 5%
(b) Company's net profit margin is 4% (as given). It is lower than the industry average of 5%, meaning that the company is earning lower profits than the other players in the industry.
asset turnover of the company = sales/assets
sales of the company = net profit/net profit margin = $200 million/0.04 = $5,000 million
asset turnover of the company = 5,000/16,000 = 0.3125
Asset turnover of the industry is more at 1.6 times, while the company's figure is 0.3125 times. This means that the company is not using its assets as productively as the industry to generate sales.
Equity multiplier of the company = total assets/total equity+retained earnings
= 16,000 million/4,000 million = 4
The company is using more debt to finance its assets than the industry, which has a equity multiplier of 1.2 times. In other words, fewer assets of the industry are financed by creditors, whereas the company is using a lot of creditor's money to finance its assets.
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