Question

Profitability Ratios The following selected data were taken from the financial statements of Vidahill Inc. for December 31, 2017, 2016, and 2015: December 31 2017 2016 2015 Total assets $4,800,000 $4,400,000 $4,000,000 Notes payable (8% interest) 2,250,000 2,250,000 2,250,000 Common stock 250,000 250,000 250,000 Preferred 4% stock, $100 par (no change during year) 500,000 500,000 500,000 Retained earnings 1,574,000 1,222,000 750,000 The 2017 net income was $372,000, and the 2016 net income was $492,000. No dividends on common stock were declared between 2015 and 2047. Preferred dividend were declared and paid in full in 2016 and 2017. a. Determine the return on total assets, the rate earned on stockholders' equity, and the return on common stockholders' equity for the years 2076 and 2017. Round to one decimal place 2017 2016 9 90 Return on total assets % 9 Rate earned on stockholders' equity Return on common stockholders' equity % 96 b. The profitability ratios indicate that Vidahill Inc.'s profitability has the rate earned on total assets in both years, there is Because the rate of return on common stockholders' equity leverage from the use of debt.

Answer 1

Solution: A

A B с D E F G 1 1. Return on Total Assets 2 Return on Assets = (Net Income + Interest) / Average total assets 3 2017 2016 4 Net Income (A) $372,000 $492,000 5 Interest Expense (B) $180,000 $180,000 6 Average Total Assets (C) $4,600,000 $4,200,000 7 Return on Total Assets [(A+B)/C] 12.0% 16.0% 8 9 2. Return on Stockholders' Equity 10 Return on Stockholders' Equity = Net Income / Average Stockholders' Equity 11 2017 2016 12 Net Income (A) $372,000 $492,000 13 Average stockholders' Equity (B) $2,148,000 $1,736,000 14 Return on Stockholders' Equity [A/B] 17.3% 28.3% 15 16 2. Return on Common Stockholders' Equity 17 Return on Common Stockholders' Equity = (Net Income - Preference Dividend) / Average Common Stockholders' Equity 18 2017 2016 19 Net Income (A) $372,000 $492,000 20 Preference dividend (B) $20,000 $20,000 21 Average stockholders' Equity (C) $1,648,000 $1,236,000 22 Return on Stockholders' Equity [(A-B)/C] 21.4% 38.2%

Working:

A c 1 1. Return on Total Assets 2 Return on Assets = (Net Income + Interest) / Average total assets 3 2017 2016 4 Net Income (A) 372000 492000 5 Interest Expense (B) =2250000*8% =2250000*8% 6 Average Total Assets (C) =(4800000+4400000)/2 =(4400000+4000000)/2 7 Return on Total Assets [(A+B)/C] =(B4+B5)/B6 =(C4+C5)/C6 8 9 2. Return on Stockholders' Equity 10 Return on Stockholders' Equity = Net Income / Average Stockholders' Equity 11 2017 2016 12 Net Income (A) 372000 492000 13 Average stockholders' Equity (B) =(250000+500000+1574000+250000+500000+1222000)/2 =(250000+500000+1222000+250000+500000+750000)/2 14 Return on Stockholders' Equity (A/B] =B12/B13 =C12/C13 15 16 2. Return on Common Stockholders' Equity 17 Return on Common Stockholders' Equity = (Net Income - Preference Dividend) / Average Common Stockholders' Equity 18 2017 2016 19 Net Income (A) 372000 492000 20 Preference dividend (B) =500000*4% =500000*4% 21 Average stockholders' Equity (C) =(250000+1574000+250000+1222000)/2 =(250000+1222000+250000+750000)/2 22 Return on Stockholders' Equity [(A-B)/C] =(B19-B20)/B21 I=(C19-C20)/C21

Solution:B

The profitability ratios indicate that the Vidahill Inc's profitability has deteriorated. Since the return on common stocckholders' Equity exceeds than the rate earned on total assets in both years, there is positive leverage from the use of debt.