Profitability ratios help in the analysis of the combined impact of liquidity ra
ID: 2817221 • 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 Sixty-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 $9,400 million in the first year and $15,037 million in the second year. Common equity was equal to $5,000 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 Sixty-Second Avenue Inc. Income Statement For the Year Ending on December 31 (Millions of dollars) Year 2 Year 1 5,080 4,000 1,120 1,040 Net Sales Operating costs except depreciation and amortization 254 1,374 1,200 3,706 2,800 Total Operating Costs Operating Income (or EBIT) Less: Interest Earnings before taxes (EBT) Less: Taxes (40%) Net Income 500 3,206 2,506 1,002 1,924 1,504 1,282 1, 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 Operating margin Profit margin Return on total assets Return on common equity Basic eaming power 70.00% 37.87% 16.00% 30.08% 24.65% 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 receive. Identify which of the following statements are true about profitability ratios. Check all that apply If a company has a profit margin of 10%, it means that the company eamed a net income of $0.10 for each dollar of sales. An increase in a company's eamings means that the profit margin is increasing. If a company's operating margin increases but its profit margin decreases, it could mean that the company paid more in interest or taxes. If a company issues new common shares but its net income does not increase, return on common equity will increaseExplanation / Answer
Answer to Part 1:
Operating Margin = Operating Income / Net Sales * 100
Year 2:
Operating Margin = 3,706 / 5,080 * 100
Operating Margin = 72.95%
Profit Margin = Net Income / Net Sales * 100
Year 1:
Profit Margin = 1,504 / 4,000 * 100
Profit Margin = 37.60%
Return on Total Assets = Net Income / Total Assets * 100
Year 2:
Return on Total Assets = 1,924 / 15,037 * 100
Return on Total Assets = 12.80%
Return on Common Equity = Net Income / Common Equity * 100
Year 2:
Return on Common Equity = 1,924 / 5,000 * 100
Return on Common Equity = 38.48%
Basic Earning Power = EBIT / Total Assets * 100
Year 1:
Basic Earning Power = 2,800 / 9,400 * 100
Basic Earning Power = 29.79%
Answer to Part 2:
If a company has a profit margin of 10%, it means that the company earned a net income of $0.10 for each dollar of sales.
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