Profitability ratios help in the analysis of the combined impact of liquidity ra
ID: 2815890 • Letter: P
Question
Profitability ratios help in the analysis of 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 Spandust Industries Inc. and make comments on its second-year performance as compared to its first-year performance. The following shows Spandust Industries Inc.'s income statement for the last two years. The company had assets of $3,525 million in the first year and $5,639 million in the second year. Common equity was equal to $1,875 million in the first year, and the company distributed 100% of its earnings out as dividends during the first and the second years. In addition, the firm did not issue new stock during either year. Spandust Industries Inc. Income Statement For the Year Ending on December 31 (Millions of dollars) Year 2 1,905 1,855 95 1,950 45 Year 1 1,500 1,723 60 1,783 283 37 246 98 148 Net Sales Operating costs except depreciation and amortization Depreciation and amortization Total Operating Costs Operating Income (or EBIT) Less: Interest Earnings before taxes (EBT) Less: Taxes (40%) Net Income 39 16 23Explanation / Answer
a.
Operating profit margin for year 2 = EBIT in year 2 / Total sales in year 2
= -$45 / $1,905
= -2.36%
Operating profit margin for year 2 is -2.36%.
b.
Net Profit Margin in year 1 = Net Profit in year 1 / Total sales in year 1
= -$148 / $1,500
= -9.87%
Net Profit Margin in year 1 is -9.87%.
c.
Return on assets in year 2 = Net Profit in year 2 / Total assets 2
= -$23 / $5,639
= -0.41%
Return on total assets is -0.41%.
d.
Retunr on equity in year 2 = Net Profit in year 2 / Total assets 2
= -$23 / $1,875
= -1.23%
Return on total assets is -1.23%.
e.
Basic Earning power in year 1 = EBIT / Total assets
= -$283 / $3,525
= -8.02%
Basic Earning power in year 1 is -8.02%.
2.
Analyst uses profitability ratio to determine trend in profit per unit of revenue. A higher operating profit margin than industry average indicates either lower operating cost of higher product price or both. If a comapny's operating margin increases and net profit margin decreases, then its means comapny use to pays more taxes and interest.
Option (C) and (C) is correct answer.
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