Question

Jerry Rice and Grain Stores has $4,030,000 in yearly sales. The firm earns 2.5 percent on each dollar of sales and turns over its assets 2 times per year. It has $165,000 in current liabilities and $323,000 in long-term liabilities.
a. What is its return on stockholders’ equity?
b. If the asset base remains the same as computed in part a, but total asset turnover goes up to 3.70, what will be the new return on stockholders’ equity? Assume that the profit margin stays the same as do current and long-term liabilities.

Answer 1

Answer:

1. Returns on stockholders' equity = 6.60%

2. Returns on stockholders' equity = 16.76%

Explanation:

Requirement 1

We know,

Returns on stockholders' equity = Net Income ÷ Stockholders' Equity

Given,

Net Income = Sales × Net Income ratio (Profit margin)

Net Income = $4,030,000 × 2.5%

Net Income = $100,750

Stockholders' Equity = Assets - liabilities

Asset Turnover = Net Sales ÷ Average total assets

or, 2 times = $4,030,000 ÷ Average total assets

or, Average total assets = $4,030,000 ÷ 2 times

Average total assets (Total Assets) = $2,015,000

Here, total assets is average total assets.

Total liabilities = Current liabilities + Long-term liabilities

Total liabilities = $165,000 + $323,000 = $488,000

Therefore, Stockholders' Equity = $2,015,000 - $488,000 = $1,527,000

Putting the values into the above formula, we get,

Returns on stockholders' equity = $100,750 ÷ $1,527,000

Returns on stockholders' equity = 0.0660

Returns on stockholders' equity = 6.60%

Requirement 2

As the asset turnover is 3.70,

Asset Turnover = Net Sales ÷ Average total assets

or, 3.70 times = $4,030,000 ÷ Average total assets

or, Average total assets = $4,030,000 ÷ 3.70 times

Average total assets (Total Assets) = $1,089,189 (Rounded to nearest dollar)

Here, total assets is average total assets.

And all the other part remain same; therefore, stockholders' equity = Total assets - total liabilities = $1,089,189 - $488,000 = $601,189

Therefore, Returns on stockholders' equity = Net Income ÷ Stockholders' Equity

Returns on stockholders' equity = $100,750 ÷ $601,189

(We get net income from requirement 1)

Therefore, Returns on stockholders' equity = 16.76%