Chapter 15, Problem 15.5BPR

1.

To determine

Financial Ratios: Financial ratios are the metrics used to evaluate the liquidity, capabilities, profitability, and overall performance of a company.

The following ratios for five years:

1. (a) Rate earned on total assets
2. (b) Return on stockholders’ equity
3. (c) Times interest earned ratio
4. (d) Ratio of total liabilities to stockholders’ equity

Explanation of Solution

Given info: Items of financial statement

a. Rate earned on total assets for five years (2012 to 2016)

$\begin{array}{c}\text{Rate earned on total assets}\left(\text{2016}\right)=\frac{\text{Net}\text{income + Interest expense}}{\text{Average total assets}}\\ =\frac{\$6,623,780}{\$25,988,665}\\ =25.5\%\end{array}$

$\begin{array}{c}\text{Rate earned on total assets}\left(\text{2015}\right)=\frac{\text{Net}\text{income + Interest expense}}{\text{Average total assets}}\\ =\frac{\$4,606,056}{\$19,859,586}\\ =23.2\%\end{array}$

$\begin{array}{c}\text{Rate earned on total assets}\left(\text{2014}\right)=\frac{\text{Net}\text{income + Interest expense}}{\text{Average total assets}}\\ =\frac{\$3,540,600}{\$14,854,406}\\ =23.8\%\end{array}$

$\begin{array}{c}\text{Rate earned on total assets}\left(\text{2013}\right)=\frac{\text{Net}\text{income + Interest expense}}{\text{Average total assets}}\\ =\frac{\$2,458,000}{\$11,370,240}\\ =21.6\%\end{array}$

$\begin{array}{c}\text{Rate earned on total assets}\left(\text{2012}\right)=\frac{\text{Net}\text{income + Interest expense}}{\text{Average total assets}}\\ =\frac{\$1,900,000}{\$8,676,000}\\ =21.9\%\end{array}$

Return on assets determines the particular company’s overall earning power. It is determined by dividing sum of net income and interest expense and average total assets.

Formula:

$\text{Rate of return on assets}=\frac{\text{Net}\text{income + Interest expense}}{\text{Average total assets}}$

b. Rate earned on stockholders’ equity for five years.

$\begin{array}{c}\begin{array}{l}\text{Rate earned on }\\ \text{stockholders' equity}\left(\text{2016}\right)\end{array}\}=\frac{\text{Net income }}{\text{Average stockholder’s equity}}\\ =\frac{\$5,571,720}{\$15,920,340}\\ =35.0\%\end{array}$

$\begin{array}{c}\begin{array}{l}\text{Rate earned on }\\ \text{stockholders' equity}\left(\text{2015}\right)\end{array}\}=\frac{\text{Net income }}{\text{Average stockholder’s equity}}\\ =\frac{\$3,714,480}{\$11,277,240}\\ =32.9\end{array}$

$\begin{array}{c}\begin{array}{l}\text{Rate earned on}\\ \text{ stockholders' equity}\left(\text{2014}\right)\end{array}\}=\frac{\text{Net income }}{\text{Average stockholder’s equity}}\\ =\frac{\$2,772,000}{\$8,034,000}\\ =34.5\%\end{array}$ $\begin{array}{c}\begin{array}{l}\text{Rate earned }\\ \text{on stockholders' equity}\left(\text{2013}\right)\end{array}\}=\frac{\text{Net income }}{\text{Average stockholder’s equity}}\\ =\frac{\$1,848,000}{\$5,724,000}\\ =32.3\%\end{array}$

$\begin{array}{c}\begin{array}{l}\text{Rate earned}\\ \text{on stockholders' equity}\left(\text{2012}\right)\end{array}\}=\frac{\text{Net income }}{\text{Average stockholder’s equity}}\\ =\frac{\$1,400,000}{\$4,100,000}\\ =34.1\%\end{array}$

Rate earned on stockholders’ equity is used to determine the relationship between the net income and the average common equity that are invested in the company.

Formula: $\begin{array}{l}\text{Rate earned on}\\ \text{ stockholders' equtiy }\end{array}\}=\frac{\text{Net income}}{\text{Average stockholder’s equity}}$

c.Number of times interest charges are earned ratio for five years

$\begin{array}{c}\begin{array}{l}\text{Number of times-interest }\\ \text{charges are earned ratio }\left(\text{2016}\right)\end{array}\}=\frac{\text{Net Income}+\text{Income}\text{tax}\text{expense}+\text{Interest expense}}{\text{Interest expense}}\\ =\frac{\$7,849,352}{\$1,052,060}\\ =7.5\text{times}\end{array}$

$\begin{array}{c}\begin{array}{l}\text{Number of times-interest }\\ \text{charges are earned ratio }\left(\text{2015}\right)\end{array}\}=\frac{\text{Net Income}+\text{Income}\text{tax}\text{expense}+\text{Interest expense}}{\text{Interest expense}}\\ =\frac{\$5,451,278}{\$891,576}\\ =6.1\text{times}\end{array}$

$\begin{array}{c}\begin{array}{l}\text{Number of times-interest }\\ \text{charges are earned ratio }\left(\text{2014}\right)\end{array}\}=\frac{\text{Net Income}+\text{Income}\text{tax}\text{expense}+\text{Interest expense}}{\text{Interest expense}}\\ =\frac{\$4,180,920}{\text{\$768,600}}\\ =5.4\text{times}\end{array}$

$\begin{array}{c}\begin{array}{l}\text{Number of times-interest }\\ \text{charges are earned ratio }\left(\text{2013}\right)\end{array}\}=\frac{\text{Net Income}+\text{Income}\text{tax}\text{expense}+\text{Interest expense}}{\text{Interest expense}}\\ =\frac{\$2,899,600}{\text{\$6,10,000}}\\ =4.8\text{times}\end{array}$

$\begin{array}{c}\begin{array}{l}\text{Number of times-interest }\\ \text{charges are earned ratio }\left(\text{2012}\right)\end{array}\}=\frac{\text{Net Income}+\text{Income}\text{tax}\text{expense}+\text{Interest expense}}{\text{Interest expense}}\\ =\frac{\$2,220,000}{\text{\$500,000}}\\ =4.4\text{times}\end{array}$

Number of times interest charges are earned ratio quantifies the number of times the earnings before interest and taxes can pay the interest expense. First, determine the sum of income before income tax and interest expense. Then, divide the sum by interest expense.

Formula: $\begin{array}{l}\text{Number of times-interest }\\ \text{charges are earned ratio }\end{array}\}=\frac{\text{Income before income tax}+\text{Interest expense}}{\text{Interest expense}}$

d. Ratio of liabilities to stockholders’ equity for five years (2012 to 2016)

$\begin{array}{c}\begin{array}{l}\text{Ratio of liabilities to}\\ \text{ stockholders' equity}\left(\text{2016}\right)\end{array}\}=\frac{\text{Total liabilities}}{\text{Stockholders' equity}}\\ =\frac{\$10,672,291}{\$18,706,200}\\ =0.6\end{array}$

$\begin{array}{c}\begin{array}{l}\text{Ratio of liabilities to}\\ \text{ stockholders' equity}\left(\text{2015}\right)\end{array}\}=\frac{\text{Total liabilities}}{\text{Stockholders' equity}}\\ =\frac{\$9,464,359}{\$13,134,480}\\ =0.7\end{array}$

$\begin{array}{c}\begin{array}{l}\text{Ratio of liabilities to}\\ \text{ stockholders' equity}\left(\text{2014}\right)\end{array}\}=\frac{\text{Total liabilities}}{\text{Stockholders' equity}}\\ =\frac{\$7,700,333}{\$9,420,000}\\ =0.8\end{array}$

$\begin{array}{c}\begin{array}{l}\text{Ratio of liabilities to}\\ \text{ stockholders' equity}\left(\text{2013}\right)\end{array}\}=\frac{\text{Total liabilities}}{\text{Stockholders' equity}}\\ =\frac{\$5,940,480}{\$6,648,000}\\ =0.9\end{array}$

$\begin{array}{c}\begin{array}{l}\text{Ratio of liabilities to}\\ \text{ stockholders' equity}\left(\text{2012}\right)\end{array}\}=\frac{\text{Total liabilities}}{\text{Stockholders' equity}}\\ =\frac{\$5,352,000}{\$4,800,000}\\ =1.1\end{array}$

Ratio of liabilities to stockholders’ equity is determined by dividing liabilities and stockholders’ equity. Liabilities are determined as the difference between ending balance of assets and stockholders’ equity.

Formula:

$\text{ Ratio of liabilities to stockholders' equity}=\frac{\text{Total liabilities}}{\text{Stockholders' equity}}$

2.

To determine

To prepare: Analysis of graphs

Explanation of Solution

• The return on total assets and return on stockholders’ equity are in increasing trend for the last five years. There is a positive use of leverage. It is evident through the above ratios.
• The ratio of liabilities to stockholders’ equity shows that the proportion of debt to stockholders’ equity is declining over the period.
• The level of debt has been relative to the equity and has improved in the five years.
• The times interest earned ratio is improving when compared to industry average.