Profitability ratios help you analyze the combined impact of liquidity ratios, a

Question

Profitability ratios help you analyze the combined impact of liquidity ratios, asset management ratios, and debt management ratios on the operating performance of a firm. Your boss has asked you to calculate the profitability ratios of Sity-Second Avenue Inc. and make comments on its second-year performance as compared to its first-year performance The following shows Sixty-Second Avenue Inc.'s income statement for the last two years. The company had assets of 4,700 million in the first year and $7,518 million in the second year. Common equity was equal to $2,500 million in the first year, 100% of earnings were paid out as dividends in the first year, and the firm did not issue new shares in the second year Sixty-Second Avenue Inc. Income Statement For the Year Ending on December 31 (Millions of dollars) Year 2 Year 1 2,540 2,000 1,855 1,723 80 1,982 1,803 197 26 Net sales Operating costs exdluding depreclation and amortization 127 Total operating costs Operating income (or EBIT Less: Interest Earnings before taxes (EBT) Less: Taxes (40%) Net income 558 75 483 193 290 68 103 Calculate the profitability ratios of Sixty-Second Avenue Inc. in the following table. Convert all calculations to a percentage rounded to two decimal places. Ratio Value Year 2 Year 1 Net profit margin Return on total assets Return on common equity Basic earning power 11.42% 2.19% 4.12% 7.42% Decision makers and analysts look deeply into profitability ratios to identify trends in a company's profitability Profitability ratios give insights into both the survivability of a company and the benefits that shareholders recelve. Identify which of the following statements are true about profitability ratios. Check all that apply. If a company has a net profit margin of 10%, it means that the company earned a net income of $0.10 for each dollar of sales. An increase in a company's earnings means that the net profit margin is increasing. If a company issues new common shares but its net income does not increase, return on common equity wil

Explanation / Answer

* Return on Equity is calculated assuming that the company paid 100% of its earnings as dividend. If company didn't pay any dividend in Year 2, The Total Equity figure to be used in Calculating ROE should be 2,500 + 290 = 2,790 and the ROE would be 10.39%.

2. The 1st option is true, if the company has anet profit margin of 10%, it means that the company earned a net income of $0.10 for each dollar of sales as Net profit margin represents the net income as a percentage of sales (Net Profit Margin = Net Profit / Sales).

Moreover, the increase in company's earnings does not mean net profit margin increase as increase in net profit and copartively high proportionate increase in sales would decrease the net profit margin

Also, issuing common equity would increase common equity, as a result the denominator in the formula (Net income / Total Equity) to calculate ROE will increase with no change in net income i.e. numerator, will lead to decrease in ROE and not increase.

Ratio Formula Year 2 Year 1 Net Profit Margin =Net Income / Sales =290/2540 =103/2000 Return on Total Assets =Net Income / Total Assets =290/7518 =103/4700 Return on common Equity =Net Income / Common Equity =290/2500 =103/2500 Basic Earning power =Operating Income / Total Assets =558/7518 =197/4700

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