If two firms differ only in their use of debt—i.e., they have identical assets, identical total invested capital, sales, operating costs, interest rates on their debt, and tax rates—but one firm has a higher total debt to total capital ratio, the firm that uses more debt will have a lower profit margin on sales and a lower return on assets.
Which of the following statements is CORRECT? a. If two firms differ only in their use of debt-i. e., they have identical assets, sales, operating costs, and tax rates-but one firm has a higher debt ratio, the firm that uses more debt will have a higher profit margin on sales. b. A firm's use of debt will have no effect on its profit margin on sales. c. The debt ratio as it is generally calculated makes an adjustment for the use of assets leased under operating leases, so the debt ratios of firms that lease different percentages of their assets are still comparable. d. If one firm has a higher debt ratio than another, we can be certain that the firm with the higher debt ratio will have the lower TIE ratio, as that ratio depends entirely on the amount of debt a firm uses. e. If two firms differ only in their use of debt-i. e., they have identical assets, sales, operating costs, interest rates on their debt, and tax rates-but one firm has a higher debt ratio, the firm that uses more debt will have a lower profit margin on sales.
E) If two firms differ only in their use of debt-i.e., they have identical assets, sales, operating costs, interest rates on their debt, and tax rates-but one firm has a higher debt ratio, the firm that uses more debt will have a lower profit margin on sales.
Explanation:
Firms that are highly leveraged, i.e. have a lot of debt, have higher costs due to interests that must be paid, so their profit margins are smaller, and their return on assets is also lower, and their risk is much higher also.
But the benefit is that the return on equity is much higher. A greater amount of debt means lower amount of equity, so any profits made must be divided by a smaller amount of stocks or smaller amount of capital invested.
The advantage of the basic earning power ratio (BEP) over the return on total assets for judging a company's operating efficiency is that the BEP does not reflect the effects of debt and taxes
Explanation:
a. This is correct.
The advantage of basic earning power ratio over the return on the total assets for judging a firm's operating efficiency is that the basic earning power does not reflect effects of debt and taxes.
b. This is incorrect.
Only the price/earnings ratio of the company will tell us nothing about a company. When we compare the price/earnings of a company with the peers, we would know whether such company is under valued, or over valued or maybe fairly valued.
c. This is incorrect.
The total assets is made up of total liabilities plus the shareholders equity, when other things are held constant, less debt simply means less liabilities. To balance both sides, the total assets should reduce as the shareholder's equity is constant. When total assets decreases, the return on the assets will increase.
d. This is incorrect.
We can reach a conclusion on which firm is better managed based on the facts given. The debt ratio is the total liabilities divided by total assets, and a lower ratio is known to be good in comparison to a higher ratio. Similarly, the profit margin is the profit divided by the sales, and low profit margin shows high expenses and also a need for the management to decrease the expense.
Recycling Inductries
1. Condensed Divisional Income Statement for the year ended Dec 31 20Y8
Business Division Consumer Division
$ $
sales 42,800,000 56,000,000
Cost of Goods Sold (23,500,000) (30,500,000)
Gross Profit 19,300,000 25,500,000
Operating expenses (11,424,800) (14,300,000)
Net Income 7,875,200 11,200,000
2. Using Duo point Analysis
Profit Margin = Net Income / sales
7,875,000 * 100% 11,200,000 * 100%
42,800,000 56,000,000
= 18.4% 20.0%
Investment Turnover = Sales / Invested asset
42,800,000 56,000,000
34,240,000 70,000,000
= 1.25 0.8
Return on Investment using Duo-point = Profit margin* Investment turnover
Business dividion = 18.4% *1.25 = 23%
Consumer division = 20% * 0.8 = 16%
3. Residual Income
Business dividion Consumer division
Net income $7,875,200 $11,200,000
Imputed cost* (3,424,000) (7,000,000)
Residual Income 4,451,200 4,200,000
4. Evaluation of performance of eaxh division
In term of profit, consumer division perform better than business division but in term of return on investment, business dividion has better performance. in term of residual income, business dividion is better in tem of performance than the consumer division.
Explanation:
a. 15.62%
b. 17.79%
c. 21.53%
Explanation:
a. The Dupont formula for calculating Return on Equity is useful here;
ROE = Net Profit margin * Asset Turnover * Assets / Equity
ROE = 3.6% * 1.88 * ( 43.4/18.8)
ROE = 15.62%
b. ROE = Net Profit margin * Asset Turnover * Assets / Equity
= 4.1% * 1.88 * ( 43.4/18.8)
= 17.79%
c. As a result of the increase in revenues, the asset turnover will increase by;
= Asset turnover * ( 1 + increase in revenue)
= 1.88 ( 1 + 21%)
= 2.2748
ROE = 4.1% * 2.2748 * ( 43.4/18.8)
= 21.53%
a.15.09624%
b. 17.19294%
c. 18.56837%
Explanation:
In this question, we use the DuPont formula which is shown below:
a. Return on equity = Net profit margin × total assets turnover × leverage factor
where,
leverage factor = Total assets ÷ book value of equity
= $44.4 million ÷ $18.4 million
= 2.41
Now the ROE equals to
= 3.6% × 1.74 × 2.41
= 15.09624%
b. If net profit margin is 4.1%, so the New ROE equals to
= 4.1% × 1.74 × 2.41
= 17.19294%
c. If revenue is increase by 23% , so it increase the asset turnover, and the new asset turnover equals to
= 1.74 × 123%
= 2.1402
Now, New ROE equals to
= 3.6% × 2.1402 × 2.41
= 18.56837%
There is not enough information to determine which firm to buy.
Option C
Explanation:
In the question above, only the profit margin of both the firms are given, but only on these basis, it cannot be decided which firm to be bought. A lot of other things are to be kept in mind while taking into consideration the decision of buying a fir.
Even if both the firms are working in the equilibrium condition which is the condition of MR = MC, then also it can not be decided, which one firm to buy.
Ionk cuz it might be 8 cuz
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