MGMT 456 Chapter 5 EXERCISES/PROBLEMS AND ANSWERS

EXERCISES/PROBLEMS AND ANSWERS

Note: for readers who were introduced to financial statements for the first time in Chapter 4, you
may want to first work the “Supplemental Exercises/Problems” presented at the end of Chapters
1, 2, and 3 which were intended for readers who had a previous understanding of financial
statements.

1. [ROA and ROE models and Ratio Components] The Salza Technology Corporation
successfully increased its “top line” sales from $375,000 in 2009 to $450,000 in 2010. Net
income also increased as did the venture’s total assets. You have been asked to compare the
financial performance between the two years.
SALZA TECHNOLOGY CORPORATION ANNUAL INCOME STATEMENTS (IN $
THOUSANDS)
2009 2010
Net sales $375 $450
Less: Cost of goods sold -225 -270
Gross profit 150 180
Less: Operating expenses -46 -46
Less: Depreciation -25 -30
Less: Interest -4 -4
Income before taxes 75 100
Less: Income taxes -20 -30
Net income $ 55 $70

Cash dividends
$ 17
$ 20

BALANCE SHEETS AS OF DECEMBER 31 (IN $ THOUSANDS)
2009 2010
Cash $ 39 $ 16
Accounts receivable 50 80
Inventories 151 204
Total current assets 240 300
Gross fixed assets 200 290
Less accumulated depreciation −95 −125
Net fixed assets 105 165
Total assets $345 $465

Accounts payable
$ 30
$ 45
Bank loan 20 27
Accrued liabilities 10 23
Total current liabilities 60 95

, Long-term debt 15 15
Common stock 85 120
Retained earnings 185 235
Total liabilities and equity $345 $465

A. Calculate the net profit margin and the sales-to-total assets ratio for Salza for 2010 using
average total assets. Also calculate the return on total assets in 2010 using average total assets.

Net profit margin: $70/$450 = 15.56%
Sales-to-average-total-assets ratio: $450/(($345 + $465)/2) = $450/$405 = 1.1111
Return on average total assets: $70/$405 = 17.28%

B. Calculate the ratios in the ROA model for both 2009 and 2010 using year-end total assets.
Comment on any financial ratio differences.

ROA model = Net income/Net sales x Net sales/Total assets = Net income/Total assets
2009: $55/$375 x $375/$345 = 14.67% x 1.0870 = 15.94%
2010: $70/$450 x $450/$465 = 15.56% x 0.9677 = 15.05%

The net profit margin increased while the sales-to-assets ratio decreased in 2010 versus
2009 with the net impact being a decline in the return on total assets ratio.

C. Expand the 2010 ROA model discussed in Part A into an ROE model that includes
financial leverage as measured by the equity multiplier. Use average owners’ or stockholders’
equity in your calculation.

ROE model = Net income/Net sales x Net sales/Average total assets x Average total
assets/Average stockholders’ equity = Net income/Average stockholders’ equity
Where: Average equity multiplier = Average total assets/Average stockholders’ equity

From Part A: ROA model = 15.56% x 1.1111 = 17.28%
Average total assets = ($345 + $465)/2 = $405

Note: Owners’ or stockholders’ equity = Common stock + Retained earnings
2009: $85 + $ 185 = $270
2010: $120 + $245 = $355
Common stock amounting to $35 in “net proceeds” ($120 - $85) was issued in 2010
Retained earnings increased by $50 in 2010 ($235 - $185) which resulted from a net
income of $70 minus cash dividends paid of $20
Average stockholders’ equity = ($270 + $355)/2 = $625/2 = $312.50

ROE model= $15.56% x 1.1111 x ($405/$312.50) = 15.56% x 1.1111 x 1.2960 = 22.41%

D. Expand the 2009 and 2010 ROA model calculations in Part B into ROE models based on
year-end owners’ or stockholders’ equity amounts.