Profitability ratios help in the analysis of the combined impact of liquidity ra

Question

Profitability ratios help in the analysis of the combined impact of liquidity ratios, asset management ratios, and debt management ratios on the operating performance of a firm Your boss has asked you to calculate the profitability ratios of Blur Corp. and make comments on its second-year performance as compared to its first-year performance. The following shows Blur Corp.'s income statement for the last two years. The company had assets of $7,050 million in the first year and $11,278 million in the second year. Common equity was equal to $3,750 million in the first year, and the company distributed 100% of its earnings out as dividends during the first and the second years. In addition, the firm did not issue new stock during either year Blur Corp Income Statement For the Year Ending on December 31 (Millions of dollars) Year 2 Year 1 3,000 1,723 120 2,046 1,843 1,157 150 1,007 403 604 Net Sales 3,810 1,855 191 Operating costs except depreciation and amortization Depreciation and amortization Total Operating Costs Operating Income (or EBIT) Less: Interest Earnings before taxes (EBT) Less: Taxes (4096) Net Income 1,764 238 1,526 610 916 Calculate the profitability ratios of Blur Corp. in the following table. Convert all calculations to a percentage rounded to two decimal places Ratio Value Year 2 Year 1 Operating margin Profit margin Return on total assets Return on common equity Basic earning power 38.57% 24.04% 8.57% 16.11% 15.64% Decision makers and analysts look deeply into profitability ratios to identify trends in a company's profitability Profitability ratios give insights into both the survivability of a company and the benefits that shareholders receive Identify which of the following statements are true about profitability ratios. Check all that apply A higher operating margin than the industry average indicates either lower operating costs, higher product pricing, or both An increase in a company's earnings means that the profit margin is increasing If a company's operating margin increases but its profit margin decreases, it could mean that the company paid more in interest or taxes. If a company issues new common shares but its net income does not increase, return on common equity will increase

Explanation / Answer

year 2 year 1

operating margin ratio 46.30 % 38.57

ebit/ net sales $1764/3810

profit margin 24.04% 20.13%   

net profit /sales = $604/3000= 20.13%

Return on total assets : 5.36% 8.57%

net income/total assets

= $916/$11278 = 5.36%

equity at the end of the year = equity at the beginning of the year + net income - dividends

so equity at the end of the yer is $3750 as all of the earnings were distributed as dividends.

so return on equity = net income/equity

= $916/$3750 = 24.43

year 2 year 1

24.43 16.11

basic earnings power

is EBIT/ TOTAL ASSETS = $1157/$7050 = 16.41%

YEAR2 YEAR 1

15.64% 16.41%

ALL THE STATEMENTS ARE TRUE, EXCEPT THE B AND D

STATEMENT d WHICH STATES THAT BY INCREASING THE EQUITY WITH NO CHANGE IN NET INCOME, THE RETURM ON EQUITY WILL FALL,

AS ROE IS NET INCOME/ EQUITY THE INCREASING EQUITY WILL BRING THE RATIO DOWN.

HIGHER OPERATING MARGIN = EBIT /SALES

THE EBIT WILL BE HIGHER DUE TO LOWER OPERATING COSTS. THE SALES WILL BE HIGHER DUE TO HIGHER VOLUME OF SALES OR DUE TO HIGHER PRICES PER PRODUCT .HIGH SALES AND LOWER COSTS WILL RESULT IN HIGH EBIT. SO THE OPERATING MARGIN WILL BE HIGHER.

IF THE EARNINGS OF THE COMPANY IS HIGH ,OBVIOSLY IT'S NET PROFIT MARGIN MARGIN WILL INCREASE IS NOT NECCESARY.

TRUE STATEMENT, THE NET PROFIT IS ARRIVED AFTER THE INTEREST AND TAXES ARE PAID. OF THE EBIT IS HIGH, BUT THE INTEREST AND TAXES ARE ALSO HIGH THE NET PROFIT WILL DECLINE.

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