Question

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 .
Item Pelican Paper, Inc. Timberland Forest, Inc.
Total assets $10,900,000 $10,900,000
Total equity (all common) 9900000 5400000
Total debt 1000000 5500000
Annual interest 100000 550000
Total sales 23000000 23000000
EBIT 5750000 5750000
Earnings available for
common stockholders 3394800 3174000
Use them in a ratio analysis that compares the​ firms' financial leverage and profitability

. The debt ratio for Pelican is

​%.

​ (Round to one decimal​ place.)

The debt ratio for Timberland is

​%.

​ (Round to one decimal​ place.)

The times interest earned ratio for Pelican is

.

​ (Round to one decimal​ place.)

The times interest earned ratio for Timberland is

.

​ (Round to one decimal​ place.)

Discuss their financial risk and ability to cover the costs in relation to each other. ​ (Select all the answers that​ apply.)

A.

Pelican has a much higher degree of financial leverage than does Timberland. As a​ result, Pelican's earnings will be more​volatile, causing the common stock owners to face greater risk.

Your answer is not correct.

B.

​Pelican's earnings will be more volatile. This additional risk is supported by the significantly lower times interest earned ratio of Pelican. Timberland can face a very large reduction in net income and still be able to cover its interest expense.

C.

​Timberland's earnings will be more volatile. This additional risk is supported by the significantly lower times interest earned ratio of Timberland. Pelican can face a very large reduction in net income and still be able to cover its interest expense.

.

D.

Timberland has a much higher degree of financial leverage than does Pelican. As a​ result, Timberland's earnings will be more​volatile, causing the common stock owners to face greater risk.

This is the correct answer.

b.  The operating profit margin for Pelican is

​%.

​ (Round to one decimal​ place.)

The operating profit margin for Timberland is

​%.

​ (Round to one decimal​ place.)

The net profit margin for Pelican is

​%.

​ (Round to two decimal​ places.)

The net profit margin for Timberland is

​%.

​ (Round to two decimal​ places)

The return on total assets for Pelican is

​%.

​ (Round to one decimal​ place.)

The return on total assets for Timberland is

​%.

​ (Round to one decimal​ place.)

The return on common equity for Pelican is

​%.

​ (Round to one decimal​ place.)

The return on common equity for Timberland is

​%.

​ (Round to one decimal​ place.)

Discuss their profitability relative to each other.  ​(Select all the answers that​ apply.)

A.

Timberland is more profitable than Pelican as shown by the higher net profit margin and return on assets.

B.

The return on equity for Pelican is higher than that of Timberland.

C.

Pelican is more profitable than Timberland as shown by the higher net profit margin and return on assets.

D.

The return on equity for Timberland is higher than that of Pelican.

This is the correct answer.

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?  ​(Select the best answer​ below.)

A.

Since Timberland has a higher relative amount of​ debt, the​stockholders' equity is proportionally reduced resulting in the higher return on equity than that obtained by Pelican. The higher ROE brings with it higher levels of financial risk for Timberland equity holders.

.

B.

Even though Pelican is more profitable​ (higher net profit​margin), Timberland has a higher ROE than Pelican due to the additional financial leverage risk.

C.

The lower profits of Timberland are due to the fact that interest expense is deducted from EBIT. Timberland has

$480,000

of interest expense to​ Pelican's

$130,000.

Even after the tax shield from the interest tax deduction​Timberland's profits are less than​ Pelican's by

$249,600.

D.

All of the above

Answer 1

Answer:

Pelican's debt ratio        9%

Timberland's debt ratio 50%

The times interest earned ratio for Pelican  57.5

The times interest earned ratio for Timberland 10.45

C is correct as Pelican has 57.5 times interest earned ratio while Timberland only 10.45 times.in other words,earnings of Timberland is more volatile.

D is also correct ,since it has financial leverage of 50.46% as against Pelican financial leverage of 9.17%

The operating margin for Pelican is 14.76%  while the operating margin for Timberland is 13.8%

Return on total assets for Pelican is 36.9%  and that of its competitor is 34.5%

The return on equity for Pelican 40.6%  and  that of Timberland is 69.6%

C is correct as Pelican is more profitable than Timberland as shown by the higher net profit margin and return on assets

B is correct, even though Pelican is more profitable​ (higher net profit​margin), Timberland has a higher ROE than Pelican due to the additional financial leverage risk.

Explanation:

All of the ratios requested for are found in the attached spreadsheet.

Download xlsx