The following information applies to the three two questions: In 2013 fiscal yea
ID: 2806182 • Letter: T
Question
The following information applies to the three two questions: In 2013 fiscal year, Central City Electric Corp. had a total asset turnover ratio (Sales/Total assets) of 2x and a ROA ratio (return on assets) of 8% and a ROE ratio (return on equity) of 12%. Assume the company used only debt and common equity What was the company's profit margin in 2013? What was the company's debt-to-capital (debt ratio) ratio? Suppose the industry has an average of ROE equal to 13.8% and an average of profit margins of 3.5%. What could you conclude about the company's ROE in comparison with the industry? What if Central City also has the same debt ratio as the industry?Explanation / Answer
We can assume few hypothetical figures here:
Asset turnover ratio of 2x which means for an assets of $10,000 the sales are $20,000
Return on assets = 8%
Net income / Total assets = 8%
Net income = 0.08 x 10,000
Net income = $800
Return on equity = 12%
Net income / Total equity = 12%
Total equity = 800/0.12 = $6,666.67
1) Profit margin = Net income / Sales = $800 / $20,000 = 4%
2) Debt to capital ratio = Total debt / Total equity
Total debt = Total assets - Total equity = $10,000 - $6,666.67
Total debt = $3,333.33
Debt to capital ratio = 3,333.33 / 6,666.67 = 0.5
Companie's ROE is below the industry average of 13.8% which mean they are giving less returns of equity holders.
The debt ratio is a healthy one as it is below 1.0 and currently stands at 0.5 which is considered to be good.
The profit margin of 4% is above the industry average of 3.5% which means a strong operating performance.
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