Question

	Beginning of the Year	End of the Year
Current assets	$62,000	$82,000
Current liabilities	25,000	55,000
Plant and equipment	300,000	350,000
Long-term liabilities	50,000	75,000
Common shareholders’ equity	125,000	225,000
Preferred shareholders’ equity	60,000	85,000

Given the following information for Victory Stables, calculate their return on assets, and return on equity and comment on the use of these ratios (why would we use them? what do they tell us?).

Net income	$50,000
Interest expense	8,500
Income tax expense	15,250
Preferred dividends	2,500

Answer 1

Return on Assets is the efficiency ratio that tests the company's ability to earn a return based on the resources available. Return on assets = ((Net Income - Preferrence dividend)/Average total assets)*100 Average total assets = (Beginning assets + Ending assets)/2= (62000+25000+300000)+(82000+55000+350000))/2 Average total assets = (Beginning assets + Ending assets)/2= $ 437,000/. Return on assets = (50000-2500)/437000)*100 Return on assets = 10.87% Approx. This indicates that the company is profitable and returning an average of 10.87% based on the assets invested into the firm. Return on equity = ((Net Income-Preferrence dividend)/Average common shareholders equity)*100 Average common shareholders equity = (Beginning common shareholders equity + Ending common shareholders equity)/2 Average common shareholders equity = (125000+225000)/2 Average common shareholders equity = $ 175,000/. Return on equity = (50000-2500)/175000)*100 Return on equity = 27.14% Approx. This indicates that the company is returning a 27.14% return to shareholder's based on the equity injected.