(Profitability and capital structure analysis) In the year that just ended, Call

ID: 2766874 • Letter: #

Question

(Profitability and capital structure analysis) In the year that just ended, Callaway Lighting had sales of $5,470,000 and incurred cost of goods sold equal to $4,460,000. The firm's operating expenses were $128,000 and its increase in retained earnings was $42,000 for the year. There are currently 99,000 common stock shares outstanding and the firm pays a $4.770 dividend per share. The firm has $1,180,000 in interest-bearing debt on which it pays 7.7 percent interest. a. (5 points) Assuming the firm's earnings are taxed at 35%, construct the firm's income statement. Income Statement Revenues $ Cost of Goods Sold Gross Profit $ Operating Expenses Net Operating Income $ Interest Expense Earnings before Taxes $ Income Taxes Net Income $ b. (5 points) Calculate the firm's operating profit margin and net profit margin. (Round to one decimal place.) The operating profit margin is % The net income margin is % c. (5 points) Compute the times interest earned ratio. The times interest earned ratio is % What does this tell you about Callaway's ability to pay its interest expense? (Fill in the blank with the times interest earned ratio from above and select the best choice.) 1) Callaway's operating income can fall as much as ______ times the interest expense and the company would still be able to service its debt. 2) Callaway's interest expense is _______ times higher than its competitors. 3) Callaway's gross profit can fall as much as ______ times and still be able to service its debt. 4) Callaway's operating income can fall as much as ______ times and still be able to repay its debt. What is the fin's return on equity? (Select the best choice.) 1) The firm's return on equity is the same as the net profit margin, 9.4%. 2) The firm's return on equity is the sum of the operating profit margin and the net profit margin, 25.5%. 3) There is not enough information to answer this question. 4) The firm's return on equity is the same as the operating profit margin, 16.1%.

Explanation / Answer

a. Callaway Lighting

Income ststement

Revenues

5,470,000

Less: Cost of goods sold

4,460,000

Gross Profit

1,010,000

Less: Operating expenses

128,000

Net Operating Income

882,000

Less: Interest Expenses ($1,180,000 * 0.077)

90,860

Earnings bsfore taxes

791,140

Income Taxes @35%

276,899

Net Income

514,241

b. Operating Profit margin:

Operating Profit Margin = Net Operating profit / Sales

Operating Profit Margin = $882,000 / $5,470,000

Operating Profit Margin = 0.161 or 16.1%

Net profit Margin:

Net profit Margin = Net Income / sales

Net profit Margin = $514,241 / $5,470,000

Net profit Margin = 0.094 or 9.4%

c. Time Interest earned ratio

Times Interest Earned ratio = EBIT / Interest Expenses

Times Interest Earned ratio = $882,000 / $90,860 = 9.71

Time Interest earned in Days = (1 / 9.71) * 360 = 37.5 days

($882,000 - $90,860) = $791140

$791140 / 90,860 = 8.7

($1,010,000 - $90,860) = $919,140

($919,140 / $90,860) = 10.12

ROE = Net Income / Equity

There is not enough information to answer this question.