the annual sales for Salco Inc. Were $4.5 million last year. The firm\'s end-of-
ID: 2674633 • Letter: T
Question
the annual sales for Salco Inc. Were $4.5 million last year. The firm's end-of-year balcance sheet was as follows.Current Assets $500,000 Liabilites $1000000
Net Fixed assets 1,500,000 Owners' equity 1,000,000
Total 2,000,000 2,000,000
The firm's income statement for the year was as follows:
Sales $4,500,000
Leass const goods sold (3,500,000)
Gross profit $1,000,000
Less operating expenses (500,000)
Operating income 500,000
Less interest expense (100,000)
Earnings before taxes $400,000
Less taxes (50%) (200,000)
net income $200,000
A.Calculate Salco's total asset turnover, operating profit margin, and operationg return on assets.
B. Salco plans to renovate one of it plants, which will require an added investment in plant and equipment of $1 million. The firm will maintain its present debt ration of .5 when financing the new investment and expects sales to remain constant. The operating profit marging will rise to 13%. What will be the new operating return on assets for Salco after plant's renovation?
C. Given that the plant renovation in part b occurs and Salco's interest expense rises by $50,000 per year what will be the return earned on the common stockholders' investment? compare this rate of return with that earned before the renovation.
Explanation / Answer
(A)
asset turnover = sales/ assets = 4500000/2000000 = 2.25
operating profit margin = op income/sales = 500000/4500000 = 11.11%
operating return on assets = op income/assets = 500000/2000000 = 25%
(B)
new assets = 2000000 + 1000000 = 3000000
sales = 4500000 (will remain same)
op margin = 13% = op income/sales
so op income = 13% * sales = 585000
new operating return on assets = new op income/new assets = 585000/3000000 = 19.5%
(C)
old net income = 200000
new net income = [new op income - new interest] * (1-tax rate)
= [585000 - (100000 + 50000)]*(1-50%)
= 217000
old equity = 1000000
new equity = 1000000 + 500000 = 1500000
{half of new loan financed through debt and rest through equity}
old ROE = 200000/1000000 = 20%
new ROE = 217000/1500000 = 14.5%
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