EBK PRINCIPLES OF MANAGERIAL FINANCE
14th Edition
ISBN: 8220100666759
Author: ZUTTER
Publisher: PEARSON
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Chapter 3, Problem 3.21P
The relationship between financial leverage and profitability Pelican Paper Inc. and Timberland Forest Inc. are rivals in the manufacture of craft papers. Some financial statement values for each company follow. Use them in a ratio analysis that compares the firms’ financial leverage and profitability.
| Item | Pelican Paper | Timberland Forest |
| Total assets | $10,000,000 | $10,000,000 |
| Total equity (all common) | 9,000,000 | 5,000,000 |
| Total debt | 1,000,000 | 5,000,000 |
| Annual interest | 100,000 | 500,000 |
| Total sales | 25,000,000 | 25,000,000 |
| EBIT | 6,250,000 | 6,250,000 |
| Earnings available for common stockholders | 3,690,000 | 3,450,000 |
- a. Calculate the following debt and coverage ratios for the two companies. Discuss their financial risk and ability to cover the costs in relation to each other.
- 1. Debt ratio
- 2. Times interest earned ratio
- b. Calculate the following profitability ratios for the two companies. Discuss their profitability relative to one another.
- 1. Operating profit margin
- 2. Net profit margin
- 3.
Return on total assets - 4.
Return on common equity
- c. In what way has the larger debt of Timberland Forest made it more profitable than Pelican Paper? What are the risks that Timberland’s investors undertake when they choose to purchase its stock instead of Pelican’s?
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Help with the realtionship between financial leverage and profitability.
Pelican Paper, Inc., and Timberland Forest, Inc., are rivals in the manufacture of craft papers. Some financial statement values for each company follow. Use them in a ratio analysis that compares the firms' financial leverage and profitability.
a. Calculate the following debt and coverage ratios for the two companies. Discuss their financial risk and ability to cover the costs in relation to each other.
(1) Debt ratio
(2) Times interest earned ratio
b. Calculate the following profitability ratios for the two companies. Discuss their profitability relative to each other.
(1) Operating profit margin
(2) Net profit margin
(3) Return on total assets
(4) Return on common equity
c. In what way has the larger debt of Timberland Forest made it more profitable than Pelican Paper? What are the risks that Timberland's investors undertake when they choose to purchase its stock instead of Pelican's?
Selected financial data for these two close competitors in the home building industry are provided below:
($ in millions)
Company A
Company B
Total assets
$40,930
$33,000
Total liabilities
21,500
13,990
Total stockholders' equity
19,430
19,010
Sales
$66,174
$47,240
Interest expense
700
350
Tax expense
1,390
1,070
Net income
2,610
1,790
1-a. Calculate the debt to equity ratio for Company A and Company B. (Round your answers to 2 decimal places.)
Debt to Equity Ratio
Company A
Company B
1-b. Which company has the higher ratio?
Company A
Company B
2-a. Calculate the times interest earned ratio for Company A and Company B. (Round your answers to 1 decimal place.)
Time Interest Earned Ratio
Company A
times
Company B
times
2-b. Which company is better able to meet interest payments as they become due?
Company A
Company B
Two companies are in the retail sales business, but their performance results are different, which is evidenced by the following data:
Financial performance ratio
Return on capital employed (ROCE)
Return on ordinary share financing (ROSF) 30%
Average debt collection period
Average debt payment period
Gross profit margin
Net profit margin
Average stock turnover period
20%
63 days
50 days
40%
10%
52 days
Comp A Company B
17%
18%
21 days
45 days
15%
10%
25 days
Perform the analysis of these data and describe the differences between these two companies. It is known that in one of them the work with consumers is well organised, while the other one is offering competitive prices. Which of these advantages are attributable to each company?
Chapter 3 Solutions
EBK PRINCIPLES OF MANAGERIAL FINANCE
Ch. 3.1 - Prob. 1FOECh. 3.1 - Prob. 2FOECh. 3.1 - Prob. 3.1RQCh. 3.1 - Describe the purpose of each of the four major...Ch. 3.1 - Prob. 3.3RQCh. 3.1 - Prob. 3.4RQCh. 3.2 - With regard to financial ratio analysis, how do...Ch. 3.2 - What is the difference between cross-sectional and...Ch. 3.2 - Prob. 3.7RQCh. 3.2 - Prob. 3.8RQ
Ch. 3.3 - Under what circumstances would the current ratio...Ch. 3.3 - In Table 3.5, most of the specific firms listed...Ch. 3.4 - To assess the firms average collection period and...Ch. 3.5 - What is financial leverage?Ch. 3.5 - What ratio measures the firms degree of...Ch. 3.6 - What three ratios of profitability appear on a...Ch. 3.6 - Prob. 3.15RQCh. 3.6 - Prob. 3.16RQCh. 3.7 - Prob. 3.17RQCh. 3.8 - Financial ratio analysis is often divided into...Ch. 3.8 - Prob. 3.19RQCh. 3.8 - What three areas of analysis are combined in the...Ch. 3 - Prob. 1ORCh. 3 - Learning Goals 3, 4, 5 ST3-1 Ratio formulas and...Ch. 3 - Prob. 3.2STPCh. 3 - Prob. 3.1WUECh. 3 - Learning Goal 1 E3-2 Explain why the income...Ch. 3 - Prob. 3.3WUECh. 3 - Prob. 3.4WUECh. 3 - Learning Goal 6 E3-5 If we know that a firm has a...Ch. 3 - Financial statement account identification Mark...Ch. 3 - Prob. 3.3PCh. 3 - Prob. 3.4PCh. 3 - Prob. 3.5PCh. 3 - Prob. 3.6PCh. 3 - Prob. 3.8PCh. 3 - Prob. 3.9PCh. 3 - Prob. 3.10PCh. 3 - Prob. 3.11PCh. 3 - Learning Goals 2, 3, 4, 5 P3-10 Ratio comparisons...Ch. 3 - Prob. 3.13PCh. 3 - Prob. 3.14PCh. 3 - Accounts receivable management The table below...Ch. 3 - Prob. 3.18PCh. 3 - Prob. 3.20PCh. 3 - The relationship between financial leverage and...Ch. 3 - Prob. 3.22PCh. 3 - Prob. 3.23PCh. 3 - Prob. 3.24PCh. 3 - Prob. 3.25PCh. 3 - Prob. 3.27PCh. 3 - Prob. 1SE
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