Selected financial data from the June 30 year-end statements of Safford Company

Question

Selected financial data from the June 30 year-end statements of Safford Company are given below Total assets Long-term debt (10% interest rate) Total stockholders equity Interest paid on long-term debt $5,100,000 $740,000 $2,200,000 $74,000 410,000 Net income Total assets at the beginning of the year were $4,900,000; total stockholders' equity was $2,000,000. The company's tax rate is 30% Required 1 Compute the return on total assets. (Round your percentage answer to 1 decimal place (i.e., 0.1234 should be entered as 12.3).) 2Compute the return on equity. (Round your percentage answer to 1 decimal place (i.e., 0.1234 should be entered as 12.3).) 3. Is financial leverage positive or negative? OPositive Negative

Explanation / Answer

Safford Corporation 1 )Return on assets ratio = net income + interest exp. x (1-tax rate)/ average total assets. ROA = $410,000 +(74000 x (1-30%)/(($4900000+$5100000)/2) 9.24% 2) Return on Equity Ratio = Net Income/ Average Shareholders' Equity ROE = $410,000 /((2,000,000 + 2,200,000)/2) 19.52% 3) After-tax interest rate = 10% x (1-30%) 7.00% ROE 19.52% Financial leverage is positive because the after-tax rate of return is higher than the after-tax rate of interest on long-term debts

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