Linda\'s Clothing is a retailer of contemporary women\'s clothing Selected finan

Question

Linda's Clothing is a retailer of contemporary women's clothing Selected financial information for Linda's appears below: 2011 20102009 2008 $978,560|$786,500 $520,6501$245,820 $ 56,759|$ 31,1501$ 15.375 $14.750 S381,500 $246,250 $145,49 S71,268 Net sales Net Income Total Assets at year-end Weighted Average number of shares Outstanding Total Liabilities at year-end Common Stockholders' Equity at year-end $175,533S126,593S 84,968 S53,645 Interest Expense 84,215 80,546 77,965 75,888 205,9679,657 60,5227,623 165 195 258 368 Required a Compute the rate of return on assets for the years 2009-2011. Linda's has an effective tax rate of 35%. b. Compute the rate of return on common shareholders' equity for the years 2009-2011 c. If Linda wants to improve its ROA, propose two scenarios to improve the operation. Provide your analysis with numeric analysis.

Explanation / Answer

a) ROA = EBIT*(1-t)/Average total assets 2011 2010 2009 2008 Net income 56759 31150 15375 14750 Interest expense 165 195 258 368 EBIT*(1-t)= NI+Interest (*1-t) 56866 31277 15543 14989 Total assets at year end 381500 246250 145490 71268 Average total assets 313875 195870 108379 ROA 18.12% 15.97% 14.34% b) Return on common stockholders' equity = NI/Average equity 2011 2010 2009 2008 Net income 56759 31150 15375 14750 Equity at year end 175533 126593 84968 53645 Average total equity 151063 105781 69307 ROE 37.57% 29.45% 22.18% c) The ROA can be decomposed into the following two ratios: NOPAT/Net sales*Net sales/Average total assets NOPAT/Net sales indicates profitability from operations after tax; interest expense not considered. Net Sales/Average total assets = Total asset turnover ratio. If Linda wants to improve the ROA, the two strategies are: *improve operating profit ratio *Improve total asset turnover For instance: The 2011 NOPAT ratio = 56866/978560 = 5.81% Total asset turnover ratio = 978560/313875 = 3.12 ROA = 5.81*3.12 = 18.12% AS can be seen, the ROA is the product of the NOPAT ratio and the total assets turnover ratio. By improving any one or both the ratios the ROA can be improved. If the TATR is improved to 4, the ROA will increase to 5.81*4 = 23.24%

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