2.1 Profitability and Per-share Ratios Flashcards

1
Q

Formula for gross profit margin percentage

A

(Net sales - COGS) / Net Sales

Gross profit / Net sales

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2
Q

A company has sales of $100,000, cost of sales of $40,000, interest expense of $4,000, taxes of $18,000, and operating expenses of $15,000. What is their operating profit margin?

A. 60%
B. 45%
C. 41%
D. 23%

A

B. 45%

Operating income = Sales - COGS - OPEX
= $100,000 - $40,000 - $15,000
= $45,000

Operating profit margin = Operating income / Net sales
= 45,000 / 100,000 = 45%

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3
Q

The Company is preparing to finalize the financial statements for the most recent year. Results are sales of $690,000, cost of sales of $378,900, and administrative expenses of $120,800. The controller has just found a sales invoice for a job completed on the last day of the year. The revenue and related costs for the job have not yet been recorded in the accounting system. The job’s revenues are $95,000 with costs totaling $65,000. What is the impact of this job on the Company’s year-end profitability?

A. A decrease in the company’s gross profit margin and an increase in the net profit margin.
B. Increase in the company’s gross profit margin and net profit margin.
C. Decreases in the company’s gross profit margin and net profit margin.
D. An increase in the company’s gross profit margin and a decrease in the net profit margin.

A

A. A decrease in the company’s gross profit margin and an increase in the net profit margin.

Gross profit margin = Gross profit / Net sales
Net profit margin = Net income / Net sales

Last job of the year:
sales will increase $95,000
Cost of sales will increase $65,000
No change to admin. expenses

Before
Sales 690,000 - COGS 378,900 = Gross profit 311,100 (45.09%)
Gross profit - admin exp 120,800 = net income $190,300 (27.58%)

After
Sales 785,000 - COGS 443,900 = Gross profit 341,100 (43.45%)
Gross profit - admin exp 120,800 = Net income 220,300 (28.06%)

Sales 95,000 - COGS 65,000 = 30,000
$30,000 increase in gross profit and $30,000 increase in net income

Gross profit margin will decrease from 45.09% to 43.45%. Net profit margin will increase from 27.58% to 28.06%

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4
Q

Formula for Return on Assets (ROA)

A

Return on assets = net income / average total assets

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5
Q

Formula for Return on Equity (ROE)

A

Return on equity = Net income / Average total equity

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6
Q

DuPont Model for ROA

A

Return on assets = net income / average total assets
= (Net income / Net sales ) x (Net sales x Average total assets)
= Net profit margin x Total asset turnover

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7
Q

DuPont Model for ROE

A

Return on equity = (Net income / Net sales ) x (Net sales x Average total assets) x (Avg. total assets / Avg. total equity)
= Net profit margin x Asset turnover x Equity multiplier
= ROA x Equity multiplier

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8
Q

The financial statements for Dividendosaurus, Inc., for the current year are as follows:

Balance Sheet
Cash $100
Accounts receivable 200
Inventory 50
Net fixed assets 600
Total $950

Accounts payable $140
Long-term debt 300
Capital stock 260
Retained earnings 250
Total $950

Statement of Income and Retained Earnings
Sales $ 3,000
Cost of goods sold (1,600)
Gross profit $ 1,400
Operations expenses (970)
Operating income $ 430
Interest expense (30)
Income before tax $ 400
Income tax (200)
Net income $ 200
Add: Jan. 1 retained earnings 150
Less: Dividends (100)
Dec. 31 retained earnings $ 250

Dividendosaurus has return on assets of

A. 21.1%
B. 39.2%
C. 42.1%
D. 45.3%

A

A. 21.1%

The return on assets is the ratio of net income to total assets. For Dividendosaurus, it equals 21.1% ($200 net income ÷ $950 total assets).

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9
Q

The financial statements for Dividendosaurus, Inc., for the current year are as follows:

Balance Sheet
Cash $100
Accounts receivable 200
Inventory 50
Net fixed assets 600
Total $950

Accounts payable $140
Long-term debt 300
Capital stock 260
Retained earnings 250
Total $950

Statement of Income and Retained Earnings
Sales $ 3,000
Cost of goods sold (1,600)
Gross profit $ 1,400
Operations expenses (970)
Operating income $ 430
Interest expense (30)
Income before tax $ 400
Income tax (200)
Net income $ 200
Add: Jan. 1 retained earnings 150
Less: Dividends (100)
Dec. 31 retained earnings $ 250

Dividendosaurus has a profit margin of

A. 6.67%
B. 13.33%
C. 14.33%
D. 46.67%

A

A. 6.67%

The profit margin is the ratio of net income to sales. For Dividendssaurus, it equals 6.67% ($200 net income / $3,000 sales)

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10
Q

In Year 3, gross profit margin remained unchanged from Year 2. But, in Year 3, the company’s net profit margin declined from the level reached in Year 2. This could have happened because, in Year 3,

A. Corporate tax rates increased.
B. Cost of goods sold increased relative to sales.
C. Sales increased at a faster rate than operating expenses.
D. Common share dividends increased.

A

A. Corporate tax rates increased.

Gross profit margin is net sales minus cost of goods sold. Net profit margin is gross profit margin minus all remaining expenses and losses, one of which is income taxes. If corporate tax rates increased, net profit margin would decrease, leaving gross profit margin unchanged.

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11
Q

A firm is experiencing a growth rate of 9% with a return on assets of 12%. If the debt ratio is 36% and the market price of the stock is $38 per share, what is the return on equity?

A. 7.68%
B. 9.0%
C. 12.0%
D. 18.75%

A

D. 18.75%

Assume that the firm has $100 in assets, with debt of $36 and equity of $64. Income (return) is $12. The $12 return on assets equates to an 18.75% return on equity ($12 ÷ $64).

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12
Q

A company has sales of $100,000, cost of sales of $40,000, interest expense of $4,000, taxes of $18,000, and operating expenses of $15,000. What is the company’s operating profit margin?

A. 60%
B. 45%
C. 41%
D. 23%

A

B. 45%

Operating profit margin is equal to operating income divided by net sales. Operating income includes COGS and operating expenses but not interest or taxes. Thus, the company’s operating income is equal to $45,000 ($100,000 sales – $40,000 COGS – $15,000 operating expenses). The amount of $45,000 divided by $100,000 of net sales results in an operating profit margin of 45%.

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13
Q

A corporation has a return on equity of 20%, a return on assets of 15%, and a dividend payout ratio of 30%. The corporation’s sustainable equity growth rate is

A. 50.0%
B. 14.0%
C. 6.0%
D. 4.5%

A

B. 14.0%

The sustainable growth rate equals the return on equity times the difference of 1 and the dividend payout ratio (1 – dividend payout ratio). Thus, the return on equity of 20% is multiplied by .7 (1.0 – .3), resulting in a sustainable equity growth rate of 14%.

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14
Q

Formula for Sustainable Growth Rate (SGR)

A

Return on Equity (ROE) x (1-dividend payout ratio)

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15
Q

A financial analyst has calculated gross profit margin and net profit margin for a company. Economists are forecasting a reduction in the corporate income tax rate. This would

A. Increase the gross profit margin and increase the net profit margin.
B. Decrease the gross profit margin and increase the net profit margin.
C. Not change the gross profit margin and increase the net profit margin.
D. Increase the gross profit margin and not change the net profit margin.

A

C. Not change the gross profit margin and increase the net profit margin.

The only components of gross profit margin are net sales and cost of goods sold. Tax expense is a component of net profit margin. A reduction in the corporate income tax rate decreases tax expense. Such a reduction, therefore, will not affect gross profit margin but will increase the net profit margin.

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16
Q

A company had $450,000 in assets, $250,000 in liabilities, and $200,000 in common equity at the beginning of the fiscal year. The company’s management is projecting that net income for the current fiscal year will be $55,000 and common equity at the end of the fiscal year will be $210,000. How much will the company’s return on equity be at the end of the fiscal year?

A. 12.2%
B. 22.0%
C. 26.8%
D. 27.5%

A

C. 26.8%

Return on equity is calculated as Net income ÷ Average equity. The net income earned in the current fiscal year is $55,000, and the average equity is $205,000 [($200,000 beginning + $210,000 ending) ÷ 2]. The return on equity is therefore 26.8% ($55,000 ÷ $205,000).

17
Q

A corporation’s return on equity can be calculated if you know its

A. Dividend yield and earnings yield.
B. Market-to-book ratio and equity multiplier.
C. Debt-equity ratio and market-to-book ratio.
D. Sustainable equity growth rate and dividend payout ratio.

A

D. Sustainable equity growth rate and dividend payout ratio.

The sustainable equity growth rate can be found by multiplying return on equity by 1 minus the dividend payout ratio. Thus, the return on equity can be derived given the sustainable growth rate and the dividend payout ratio.

18
Q

A company’s year-end selected financial data is shown below.
Year 2 & Year 1
Current assets $250,000 & $175,000
Total assets 600,000 & 500,000
Total liabilities 300,000 & 225,000
Net sales 200,000 & 150,000
Net income 75,000 & 60,000

The company’s rate of return on assets and rate of return on equity for Year 2 are

A. 13% and 25%, respectively
B. 35% and 25%, respectively
C. 12% and 22%, respectively
D. 14% and 26%, respectively

A

D. 14% and 26%, respectively

Return on assets = net income / average total assets. The return on assets equals 14% {$75,000 / [($600,000 + 500,000) / 2]}.

Return on equity = net income / average total equity.
Total equity = total assets - total liabilities.
Thus, the return on equity equals 26% {$75,000 / [($300,000 + $275,000) / 2]}.

19
Q

Which of the outcomes represented in the following table would result from a company’s retirement of debt with excess cash?

Total Assets Turnover Ratio: Increase/Decrease
Following Period’s Times Interest Earned Ratio: Increase/Decrease

A

Total Assets Turnover Ratio: Increase
Following Period’s Times Interest Earned Ratio: Increase

Because total assets will decline without any impact on sales, the total assets turnover ratio (sales / total assets) will increase. In addition, a reduced debt level should cause a reduction in annual interest payments, so the time interest earned ratio [(net income + Interest + Taxes) / Interest] should increase.

20
Q

At the end of Year 1, a company had average total assets of ¥450 million, average total liabilities of ¥150 million, and net income of ¥135 million. The company’s management projects average total assets to increase by ¥50 million in Year 2 due to the planned purchase of a new manufacturing plant. The company will issue ¥30 million in new debt at the beginning of Year 2. No debt was paid down during Year 1. If management projects net income to increase by 25% in Year 2, by approximately how much does the company’s return on total assets increase between Year 1 and Year 2?

A. 11%
B. 17%
C. 20%
D. 13%

A

D. 13%

The original return on assets was 30% (135 / 450). A 25% increase in income and an increase in assets results in a 33.75% return on assets (168.75 / 500). Dividing 33.75% by 30% results in a ratio of 1.125, or approximately a 13% increase.

21
Q

Based on potential sales of 500 units per year, a new product has estimated traceable costs of $990,000. What is the target price to obtain a 15% profit margin on sales?

A. $1,980
B. $2,329
C. $1,935
D. $2,277

A

B. $2,329

Costs of the product must be 85% of sales to achieve a 15% profit on sales. Thus, sales must be $1,164,706 ($990,000 / 0.85). The price per unit is $2,329 ($1,164,706 / 500).

22
Q

According to its public financial statements, a company’s gross profit margin decreased by 5% while its operating profit margin increased by 3%. Which one of the following factors could cause both of these changes?

A. A change to the variable costing income statement format.
B. Sale of fully-depreciated production machinery at a gain and replacement of the machines with newer models.
C. A lowered selling price to increase quantities sold.
D. An increase in the cost per unit of the goods purchased from a supplier.

A

C. A lowered selling price to increase quantities sold.

The lower price could reduce gross profit, but the increased volume would increase overall profit margin because there would not be any increase in general and administrative expenses.

23
Q

Two companies have identical return on assets. Company X purchased most of its assets many years ago when prices were relatively low. Company Y purchased most of its assets in recent years when prices were relatively high. Both companies have identical debt levels, and record their assets at historical cost. The return on assets ratio is most likely

A. Overstated for Company X.
B. Overstated for both companies.
C. Accurate for both companies.
D. Overstated for Company Y.

A

A. Overstated for Company X.

The return on assets equals net income divided by average total assets. Both companies have identical returns on assets and record assets at historical cost. Since company X purchased most assets at relatively low prices, the net income is also relatively low compared with Company Y. Thus, the return on assets ratio is overstated for Company X.

24
Q

When a fixed asset is sold for less than book value, which one of the following will decrease?

A. Total current assets.
B. Net working capital.
C. Net profit.
D. Current ratio.

A

C. Net profit.

When an asset is sold for less than book value, an accrual-basis loss is incurred. This reduces net profit.

25
Q

Selected items from the equity section of a company’s balance sheet are shown below.

Year 2, Year 1
Common stock, 5,000,000 shares $ 50,000,000, $ 50,000,000
Total equity 200,000,000, 182,500,000

The increase in equity was caused by $20,000,000 in net income less a common stock dividend payment of $0.50 per share. The company’s sustainable growth rate is

A. 8.75%
B. 9.59%
C. 9.15%
D. 10.46%

A

C. 9.15%

The sustainable growth rate equals the return on equity (ROE) times the difference of 1 and the dividend payout ratio.

The ROE equals net income / average total equity.

Sustainable growth rate = ROE x (1 - Dividend payout ratio)
= {$20,000,000 / [($200,000,000 + $182,500,000) / 2]} x [1 - ($2,500,000 / $20,000,000}]
= ($20,000,000 / $191,250,000) x (1 - 0.125)
= 0.1046 x 0.875
= 0.0915
= 9.15%

26
Q

A company has a net profit margin of 5%, an operating profit margin of 10%, and a gross profit margin of 25%. Sales revenue is $5,000,000. Selling, general, and administrative expenses are $750,000. What is the cost of goods sold?

A. $4,750,000
B. $3,750,000
C. $4,250,000
D. $3,250,000

A

B. $3,750,000

Gross profit is equal to sales revenue minus cost of goods sold. Thus, the cost of goods sold is equal to sales revenue minus gross profit. Given a gross profit percentage of 25% and sales revenue of $5,000,000, the gross profit is $1,250,000 ($5,000,000 x 25%), and cost of goods sold is $3,750,000 ($5,000,000 - $1,250,000)