Question:
You are a part-time financial advisor. A client is considering an investment in common stock of a waste
recycling firm. One motivation is a rumor the client heard that the company made huge investments in a
new fuel creation process. Unable to confirm the rumor, your client asks you to determine whether the
firm’s assets had recently increased significantly.
Because the firm is small, information is sparse. Last quarter’s interim report showed total assets of $324
million, approximately the same as last year’s annual report. The only information more current than that
is a press release last week in which the company’s management reported “record net income for the year
of $21 million, representing a 14.0% return on shareholders’ equity. Performance was enhanced by the
Company’s judicious use of financial leverage on a debt/equity ratio of 2 to 1.”
Required:
Use the information available to provide your client with an opinion as to whether the waste recycling
firm invested in the new fuel creation process during the last quarter of the year.
Answer:
Apparently, a significant increase in assets occurred during the last quarter. Total assets were $324
million and now they total $450 million, as can be calculated as follows:
Return on shareholders’ equity = Net income ÷ Shareholders’ equity = 14%
Shareholders’ equity = $21 million ÷ 14% = $150 million
Debt to equity ratio = Total liabilities ÷ Shareholders’ equity = 2
Total liabilities = $150 million x 2 = $300 million
Total assets = Total liabilities + Shareholders’ equity
= $300 million + 150 million = $450 million
You are a part-time financial advisor. A client is considering an investment in common stock of a waste
recycling firm. One motivation is a rumor the client heard that the company made huge investments in a
new fuel creation process. Unable to confirm the rumor, your client asks you to determine whether the
firm’s assets had recently increased significantly.
Because the firm is small, information is sparse. Last quarter’s interim report showed total assets of $324
million, approximately the same as last year’s annual report. The only information more current than that
is a press release last week in which the company’s management reported “record net income for the year
of $21 million, representing a 14.0% return on shareholders’ equity. Performance was enhanced by the
Company’s judicious use of financial leverage on a debt/equity ratio of 2 to 1.”
Required:
Use the information available to provide your client with an opinion as to whether the waste recycling
firm invested in the new fuel creation process during the last quarter of the year.
Answer:
Apparently, a significant increase in assets occurred during the last quarter. Total assets were $324
million and now they total $450 million, as can be calculated as follows:
Return on shareholders’ equity = Net income ÷ Shareholders’ equity = 14%
Shareholders’ equity = $21 million ÷ 14% = $150 million
Debt to equity ratio = Total liabilities ÷ Shareholders’ equity = 2
Total liabilities = $150 million x 2 = $300 million
Total assets = Total liabilities + Shareholders’ equity
= $300 million + 150 million = $450 million
