December 31
2014 2013 2012
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $4,800,000 $4,400,000 $4,000,000
Notes payable (8% interest) . . . . . . . . . . . . . . . . . . . . . . . . . . 2,250,000 2,250,000 2,250,000
Common stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 250,000 250,000 250,000
Preferred 4% stock, $100 par
(no change during year) . . . . . . . . . . . . . . . . . . . . . . . . . . . 500,000 500,000 500,000
Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,574,000 1,222,000 750,000
The 2014 net income was $372,000, and the 2013 net income was $492,000. No dividends on common stock were declared between 2012 and 2014.
a. Determine the rate earned on total assets, the rate earned on stockholders’ equity, and the rate earned on common stockholders’ equity for the years 2013 and 2014. Round to one decimal place.
b. What conclusions can be drawn from these data as to the company’s profitability?
Answer:
Net Income + Interest Expense
a. Rate Earned on Total Assets = Average Total Assets
2014:
2013:
$372,000 + $180,000 1
$4,600,000 2
$492,000 + $180,000 3
$4,200,000 4
= 12.0%
= 16.0%
1 $2,250,000 × 8%
2 ($4,800,000 + $4,400,000) ÷ 2
3 $2,250,000 × 8%
4 ($4,400,000 + $4,000,000) ÷ 2
Rate Earned on
Stockholders’ Equity = Net Income
Average Total Stockholders’ Equity
$372,000
2014: = $2,148,000 *
17.3%
$492,000
2013: = $1,736,000 **
* ($2,324,000 + $1,972,000) ÷ 2
** ($1,972,000 + $1,500,000) ÷ 2
28.3%
Rate Earned on Common Net Income – Preferred Dividends
Stockholders’ Equity = Average Common Stockholders’ Equity
$372,000 – $20,000 1
2014: $1,648,000 2 = 21.4%
2013: $492,000 – $20,000 3
$1,236,000 4 = 38.2%
1 $500,000 × 4%
2 ($1,824,000 + $1,472,000) ÷ 2
3 $500,000 × 4%
4 ($1,472,000 + $1,000,000) ÷ 2
b. The profitability ratios indicate that Robinson Inc.’s profitability has deteriorated. Most of this change is from net income falling from $492,000 in 2013 to $372,000 in 2014. Since the rate of return on assets exceeds this amount in both years, there is positive leverage from the use of debt. However, this leverage is greater in 2013 because the rate of return on assets exceeds the cost of debt by a greater amount in 2013.