(a)
Annual Report: It is a comprehensive financial report that shows all the business activities that takes place throughout the previous financial year. Its purpose is to provide the complete financial information of a company’s financial activities to its users in order to help them analyze and take well informed decisions.
Financial Ratios: Financial ratios are the metrics used to evaluate the overall financial performance of a company during a specific period of time.
To Compute: the return on common
(a)
Answer to Problem 11.3EYCT
Compute the return on common stockholders’ equity:
For Incorporation A
For Incorporation W
Working notes:
Compute average stockholders’ equity for Incorporation A.
Compute average stockholders’ equity for Incorporation W.
Explanation of Solution
Return on common stockholders’ equity ratio: It is a profitability ratio that measures the profit generating ability of the company from the invested money of the shareholders. The formula to calculate the return on common stockholders’ equity is as follows:
Therefore, for Incorporation A the Return on Common Stockholders’ equity is (2.4%) and, for Incorporation W the Return on Common Stockholders’ equity is 20.8%
To Compute: the debt to assets ratio for Incorporation A and Incorporation W.
Answer to Problem 11.3EYCT
Compute the debt to assets ratio:
For Incorporation A
For Incorporation W
Working note:
Compute total liabilities value for Incorporation A.
Compute total liabilities value for Incorporation W.
Explanation of Solution
Debt to assets ratio: It is the ratio that measures the ability of a company to meet its long-term obligations out of its total assets available. It shows the relationship of total liabilities and total assets.
The formula to calculate the debt to assets ratio is as follows:
Therefore, for Incorporation A the Debt to assets ratio is 80.3% and, for Incorporation W the Debt to assets ratio is 57.8%.
To Compute: the return on assets ratio for Incorporation A and Incorporation W.
Answer to Problem 11.3EYCT
Compute the return on assets ratio:
For Incorporation A
For Incorporation W
Working notes:
Compute average total assets for Incorporation A.
Compute average total assets for Incorporation W.
Explanation of Solution
Return on assets is used to measure the overall earning ability of the company. Thus, it shows the relationship between the net income and the average total assets.
The formula to calculate the return on assets ratio is as follows:
Therefore, for Incorporation A the Return on assets is (0.5%) and, for Incorporation W the Return on assets is 8.0%.
(b)
To explain: the conclusions concerning the companies’ profitability ratios can be drawn on these ratios.
(b)
Explanation of Solution
From the above calculated ratios in part a, the following conclusions can be drawn concerning both companies’ profitability:
- Return on assets for Incorporation A is negative, that is, (0.5%) and that of Incorporation W is 8.0%. Thus, the positive ratio percentage of Incorporation W indicates that it is more profitable by generating more net income through effective utilization of total assets.
- Return on stockholders’ equity for Incorporation A is negative, that is, (2.4%) and that of Incorporation W is 20.8%. Thus, the positive ratio percentage of Incorporation W indicates that it is more profitable as its shareholders could earn good income from each equity share available to common stockholders.
To find: the company that relies more on debt to boost its return to common shareholders.
Answer to Problem 11.3EYCT
Incorporation A is the company that relies more on debt to boost its return to common shareholders.
Explanation of Solution
Debt to assets for Incorporation A is 80.3%. Thus, the higher ratio percentage of Incorporation A indicates that it relies more on the borrowed funds than its own available assets. Since its interest rate on borrowed funds is more than its return on assets, it provides could not provide good return on common stockholders’ equity.
However, more reliance on debts than assets for Incorporation A has lead to negative return on assets and return on common stockholders’ equity. This would again, increase the risk of non-repayment of debts in future and would adversely affect its liquidity position.
(c)
To Compute: the payout ratio for Incorporation A and Incorporation W.
(c)
Answer to Problem 11.3EYCT
Compute the payout ratio:
For Incorporation A
For Incorporation W
Explanation of Solution
Payout Ratio: It refers to a measure that evaluates the amount of dividends paid to the shareholders out of the net income earned by a corporation. It is generally expressed as a percentage. The formula to calculate the payout ratio is as follows:
Therefore, for Incorporation A the Payout ratio is 0% and, for Incorporation W the Payout ratio is 37.8%.
To find: which company pays out a higher percentage of its earnings.
Explanation of Solution
Incorporation W has a higher percentage of payout ratio of 37.8%. However, Incorporation A with negative net income could not declare any dividends to be paid to its shareholders in the year 2014
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Chapter 11 Solutions
FINANCIAL ACCOUNTING: TOOLS WP ACCESS
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