Accounting Assignment Solution Chapter5

Chapter 5 Financial Statement Analysis Exercises and Solutions

TF Exercise Solution –

1. F – Return on common stockholders’ equity
2. T
3. F – Solvency or leverage
4. F – A large solvency or leverage ratio
5. T
6. F – Just opposite
7. F – Just opposite (skip this question)
8. T

Exercise 1 – Ratio Analysis of Profitability

1. Return on Equity (ROE) = NI / Average SE

= $100,000 / $400,000 = 25%

1. Return on Assets (ROA)

Earnings without Interest (EWI) = NI + Interest Expense x (1 – Tax Rate)

= $100,000 + $40,000 x (1 – 40%) = $124,000

ROA = EWI / Average TA

               = $124,000 / $800,000 = 15.5%

1. Return on Financial Leverage (ROFL)

ROFL = ROE - ROA

                   = 25% - 15.5% = 9.5%

(4)   Profit Margin (PM)

        PM = EBI / Sales

               = $124,000 / $1,600,000 =  7.75%

1. Assets Turnover (AT)

AT = Sales / Average TA = $1,600,000 / $800,000 = 2

Exercise 2 – Ratio Analysis of Profitability and Risks

    a. Return on equity (ROE)

        ROE = NI / Average SE

               = $84,000 / 0.5 ($320,000 + $332,000)

               = $84,000 / $326,000 = 25.8%

    b. Return on assets (ROA)

        Total Assets (TA): Jan. 1 -- $180,000 + $255,000 = $435,000

              Dec. 31: $210,000 + $275,000 = $485,000

        Earnings without Interest (EWI) = $84,000 + $3,000 x (1-30%) = $86,000

      ROA = EWI / Average TA