8
Profitability
TO Chapter THE NET
1. a. SIC 7370 Services Computer Programming, Data Processing, Etc.
b. Item 1 business
Google is a global technology leader focused on improving the ways people
connect with information.
c.
Revenue
Income from operations
Net income
2004
100.0
100.0
100.0
2005
192.5
315.1
367.2
2006
332.5
554.5
771.1
d. These are gigantic numbers. The issue will be when will these numbers subside.
2. a. SIC 2000 Food and Kindred Products
b. Item 1 Business
The Company
Flower Foods is one of the largest producers and marketers of bakery products
in the United States.
c.
Flower Foods, Inc. and Subsidiaries
Consolidated Statements of Income (in part)
For the 52 weeks ended
(Amounts in thousands)
Sales
December
30,
2006
$
1,888,654
861,583
779,437
759,387
64,250
118,493
217
$ 1,551,30
8
949,612
Materials, supplies, labor and other
production costs (exclusive of depreciation
and amortization, shown separately below)
Selling, marketing, and administrative
expenses
Depreciation and amortization
Income from operations
December
31,
2005
$
1,715,869
January 1,
2005
695,656
59,344
99,286
632,895
56,702
82,274
d.
Flower Foods, Inc. and Subsidiaries
Consolidated Statements of Income (in part)
Horizontal Common-Size Analysis
Sales
Materials, supplies, labor and
other production costs
(exclusive of depreciation
and amortization, shown
separately below)
Selling, marketing and
administrative expenses
Depreciation and amortization
Income from operations
For the 52 weeks ended
December 30,
December
January 1,
2006
31, 2005
2005
121.7
110.6
100.0
121.8
110.5
100.0
120.0
113.3
144.0
109.9
104.7
120.7
100.0
100.0
100.0
e. These years are comparable, each years has 52 weeks.
f. All items increased materially, except for depreciation and amortization. Income
from operations increased materially more than the other items.
3. a. 1. SIC 3674 Semiconductors & Related Devices
2. Item 1 Business
Industry
We are the worlds largest semiconductor chip maker, based on revenue.
3.
Intel Corporation
Consolidated Statements of Income (in part)
Three Years Ended December 30, 2006
(In Millions)
Net revenue
Cost of sales
Gross margin
Operating income
(1)
2006(1)
$35,382
17,164
18,218
5,652
2005
$38,826
15,777
23,049
12,090
2004
$34,209
14,463
19,746
10,130
Cost of sales and operating expenses for the year ended December 31,
2006 include share-based compensation.
218
b. 1. SIC 3674 Semiconductors & Related Devices
2. Item 1 Business
General
We are a global semiconductor company with facilities around the world.
3.
Advanced Micro Devices, Inc.
Consolidated Statement of Operations (in part)
Three Years Ended December 31, 2006
(In thousands)
Total net revenue
Cost of sales
Gross margin
Operating income (loss)
2006
$5,649
2,856
2,793
(47)
2005
$5,848
3,456
2,392
232
2004
$5,001
3,033
1,968
222
c. Intel appears to have preformed better. Operating income declined materially for
Intel but it did not go into a loss.
There are some good indications for Advanced Micro Devices., especially the
increase in gross margin. The increase in gross margin would be a cause for
picking Micro Devices.
4. a. 1. SIC 3711 Motor Vehicles & Passenger Car Bodies
2.
Ford Motor Company and Subsidiaries
Consolidated Statement of Income (in part)
For the Years Ended December 31, 2006, 2005, and 2004
(In millions)
For the Years Ended December 31, 2006, 2005, and 2004
(in millions)
2006
2005
2004
Automotive:
Sales
$143,307
$153,474
$147,119
Total cost and expenses
161,228
157,662
147,319
Operating Income (loss)
(17,921)
(4,188)
(200)
Financial services:
Revenues
16,816
23,422
25,197
Total costs and expenses
14,850
19,564
20,910
Income/(loss) before income taxesfinancial services
1,966
4,953
4,287
219
3. The trend is very negative for both automotive and financial services.
Financial services did maintain a profit while automotive had losses in billions.
b. 1. SIC 3711 Motor Vehicles & Passenger Car Bodies
2.
General Motors Corporation and Subsidiaries
Consolidated Statement of Operations
(Dollars in millions, except per share amounts)
2006
Net sales and revenues:
Automotive sales
Financial services and insurance
revenues
Total net sales and revenues
Cost and expenses:
Automotive cost of sales
Selling, general, and administrative
expenses
Interest expense
Provisions for credit and insurance losses
related to financing and insurance
operations
Other expenses
Total costs and expenses
Operating loss
2005
2004
$172,927
$160,228
$163,341
34,422
207,349
34,427
194,655
32,010
195,351
164,682
158,887
152,115
25,081
16,945
27,513
15,607
25,969
11,913
3,430
7,024
212,461
(17,806)
4,315
1,584
194,896
(545)
4,071
4,238
215,017
(7,668)
3. Automotive
2006
$ 172,9
27
164,6
82
$ 8,245
Automotive sales
Automotive cost of sales
Gross profit
2005
$ 160,2
28
158,8
87
$ 1,341
2004
$ 163,3
41
152,1
15
$ 11,22
6
Trend is negative on gross profit.
Revenue:
Financial services and insurance revenues
$ 34,4
22
$ 34,4
27
$ 32,0
10
A modest increase in revenue. The trend was not good for either automotive
or financial services and insurance revenues.
220
c. Neither performed good. General Motors performed better because its loss was
much less than the Ford loss. Also, General Motors is a much bigger company
than Ford.
QUESTIONS
8- 1.
Profits can be compared to the sales from which they are the residual. They can
be compared to the assets that generate sales. Or, they can be viewed as return
to the owner. Each measure looks at profits differently. The trends might move
in different directions, depending on the base.
8- 2.
Extraordinary items are by nature nonrecurring. They should be segregated in
order to concentrate on profit that will be expected in the next period. Recurring
earnings should be used in trend analysis of profitability.
8- 3.
Expenses as a percent of sales must have increased if profits as a percent of
sales declined.
8- 4.
Profit margin in jewelry is usually much higher than in groceries. Groceries
generate total profits based on volume of sales rather than high markup.
8- 5.
A drop in profits or a rise in the asset base could cause a decline in the ratio. For
example, higher cost of sales could cause a decline; or, a substantial investment
in fixed assets that are not yet fully utilized could cause a decline.
8- 6.
DuPont analysis relates return on assets to turnover and margin. It allows for
further analysis of return on assets by this breakdown.
8- 7.
Operating income is sales minus cost of sales and operating expenses. It does
not include nonoperating items, such as other income, interest, and taxes.
Operating assets are basically current assets plus plant, property, and
equipment. They do not include investments, intangibles, and other assets.
Removing non-operating items from the DuPont analysis gives a clearer picture
of productive operations.
8- 8.
Equity earnings are the owners proportionate share of the nonconsolidated
subsidiary earnings. These earnings are usually greater than the cash from
dividends from the nonconsolidated subsidiary.
8- 9. Return on assets is a function of net profit margin and total asset turnover.
Return on assets could decline, given an increase in net profit margin, if the total
asset turnover declined sufficiently.
221
8-10. Return on investment measures return to all long-term supplies of funds. It
includes net income plus tax-adjusted interest in the numerator and all long-term
funds in the denominator. Return on total equity is just return to shareholders.
Return on common equity is return only to common shareholders. Net income is
reduced by preferred dividends in the numerator, and only common equity is in
the denominator.
8-11. Return on investment is a profitability measure comparing income to capital
utilized by the firm. Some measures are return on assts, return on equity, or
income available to all capital sources, divided by capital. The given ratio is
preferred, since it measures the profit available to all long-term sources of capital
against that capital. The interest is multiplied by the tax adjustment factor to put
interest on an after-tax basis.
8-12. This cannot be determined based only upon the absolute measures. It is
necessary to compare these dollar figures to a base, such as investment or
sales. Also, it is necessary to know if nonrecurring items are part of the firms
income picture.
8-13. Interim reports are less reliable because they are not audited, but they can be
very meaningful in indicating trends before the end of the year.
8-14. An objective considered here is timeliness rather than completeness. Full
statements would take too long and involve too much cost to produce.
8-15. Comprehensive income includes net changes in (a) foreign currency translation
adjustments, (b) unrealized holding gains and losses on available-for-sale
marketable securities, and (c) changes to stockholders equity resulting from
additional minimum pension liability adjustment. These items will tend to
fluctuate more than other income items.
8-16. Pro forma financial information is hypothetical or a projected amount. Used
improperly pro forma financial information can be a negative contribution to
financial reporting.
222
PROBLEMS
PROBLEM 8-1
Net Profit Margin
Net Income Before Minority Share
of Earnings, Equity Income and
Nonrecurring Items
Net Sales
=
2007
$52,500
$1,050,000
= 5.00%
Return on Assets
2006
$40,000
$1,000,0
00
= 4.00%
Net Income Before Minority Share
of Earnings and Nonrecurring
Items
Average Total Assets
=
2007
$52,500
2006
$40,00
0
$200,0
00
$230,000
= 22.83%
Total Asset Turnover
Net Sales
Average Total
Assets
=
2007
$1,050,000
$230,000
=4.57 times
per year
Return on Common Equity
=
20.00%
=
2006
$1,000,0
00
$200,000
=5.00
times
per year
Net Income Before
223
Nonrecurring Items Preferred
Dividends
Average Common Equity
2007
$52,500
$170,000
2006
$40,000
$160,000
= 30.88%
= 25.00%
224
Ahl Enterprise has had a substantial rise in profit to sales. This is somewhat
tempered by a reduction in asset turnover. Given a slight rise in common equity,
there is a substantial rise in return on common equity.
PROBLEM 8-2
a.
2007
100.0%
60.7
39.3
14.6
10.0
14.7
5.9
8.8%
Sales
Cost of goods sold
Gross profit
Selling expense
General expense
Operating income
Income tax
Net income
b.
2006
100.0%
60.8
39.2
20.0
8.3
10.9
4.2
6.7%
Starr Canning has had a sharp decrease in selling expense coupled with only a
modest rise in general expenses giving an overall rise in the net profit margin.
PROBLEM 8-3
Earnings before interest and tax
$
Interest (750,000 x 6%)
Earnings before tax
$
Tax
Net income
$
Preferred dividends
Income available to common
$
Return on
a.
Assets
=
245,0
00
45,00
0
200,0
00
80,00
0
120,0
00
15,00
0
105,0
00
Net Income Before Minority Share
of Earnings and Nonrecurring
Items
Ending Total Assets
225
=
$120,000
$3,000,000
4.00
=
%
b.
Return on Total
Equity
=
Net Income Before
Nonrecurring Items Dividends
on
6.67
Redeemable Preferred Stock
= $120,000 =
%
Ending Total Equity
$1,800,000
226
c.
Return on Common
Equity
=
Net Income Before Nonrecurring Items
Preferred Dividends
Ending Common Equity
$120,000 $15,000
=
$1,500,000
d.
Times Interest
Earned
=
Recurring Earnings, Excluding
Interest Expense, Tax Expense
Equity Earnings, and Minority
Earnings
Interest Expense, Including
Capitalized Interest
7.00
%
$245,0
5.44
=
00
= times
$45,000
per year
PROBLEM 8-4
Sales
Sales returns
Cost of goods sold
Selling expense
General expense
Other income
Other expense
Income tax
Net income
Vent Molded
Plastics
101.0%
1.0
72.1
9.4
7.0
0.4
1.5
4.8
5.5%
Plastics
Industry
100.3%
0.3
67.1
10.1
7.9
0.4
1.3
5.5
8.5%
Sales returns are higher than the industry. Cost of sales is much higher, offset
somewhat by lower operating expenses. Other expense (perhaps interest) is
somewhat higher. Lower taxes are perhaps caused by lower income. Overall
profit is less, primarily due to cost of sales.
227
PROBLEM 8-5
a.
$1,589,1
50
$1,294,966
122.72
%
=
2007 sales were 122.72% of those in 2006.
b.
$138,2
04
$137,110
100.80
%
=
2007 net earnings were 100.80% of those in 2006.
c.
1 Net Profit
. Margin
2007
$149,260
$1,589,150
=
=
2 Return on
. Assets
2007
$149,260
$1,437,636
2006
$149,760
$1,294,9
66
9.39
%
=
2006
$149,760
$1,182,1
10
10.38
%
=
=
=
11.56
%
Net Income Before Minority Share
of Earnings and Nonrecurring
Items
Ending Total Assets
=
3 Total Asset
. Turnover
2007
$1,589,150
$1,437,636
Net Income Before Minority Share of
Earnings, Equity Income and Nonrecurring
Items
Net Sales
=
12.67
%
Net Sales
Average Total
Assets
2006
$1,294,966
$1,182,110
1.11
times
228
=
1.10 times
4 DuPont
. Analysis:
2007
2006
Return on
Assets
=
Net Profit
Margin
x
Total Asset
Turnover
10.42*
12.72*
=
=
9.39%
11.56%
x
x
1.11
1.10
*Rounding causes the difference from the 10.38% and 12.67% computed in (2).
229
5.
2007
Operating income
Net sales
2006
1,589,1
50
651,39
$
0
135,31
4
526,68
0
275,76
$
6
$ 1,294,9
66
$ 466,25
0
113,10
0
446,11
0
$ 269,50
6
$
Less: Cost of product sold
Research and development expenses
General and selling
Operating income
Operating Income Margin
Operating
Income
Net Sales
=
2007
$275,766
$1,589,150
= 17.35%
6.
Return on Operating
Assets
2006
$269,506
$1,294,9
66
= 20.81%
=
Operating Income
Ending Operating Assets
2007
$275,766
$1,411,686
= 19.53%
7.
Operating Asset Turnover
2006
$269,506
$1,159,6
66
= 23.24%
=
Net Sales
Ending Operating Assets
2007
$1,589,150
$1,411,686
= 1.13 times
per year
230
2006
$1,294,9
66
$1,159,6
66
= 1.12
times per
year
8.
DuPont
Analysis:
2007:
2006:
=
19.61%*
23.31%*
Operating
Income
Margin
x
Operating
Asset
Turnover
=
=
Return on
Assets
17.35%
20.81
x
x
1.13
1.12
*Rounding causes the difference from the 19.53% and 23.24% computed in (6).
231
9.
Return on
Investment
=
Net Income Before Minority Share of Earnings and
Nonrecurring Items + [(Interest Expense) x (1 Tax
Rate)]
Ending (Long-Term Liabilities) + Equity
2007
149,26
$
0
18,768
Net earnings before minority share
Interest expense
Earnings before tax
Provision for income tax
Tax rate
1 tax rate
Interest expense x (1 tax rate)
Net earnings before minority share +
interest expense x 1(1 tax rate)]
Long-term debt and equity
Return on investment
Return on Common
10.
Equity
=
263,76
2
114,50
2
43.4 %
56.6 %
10,623
159,88
3
1,019,4
20
15.7 %
2006
$ 149,7
60
11,52
2
271,5
00
121,7
40
44.8 %
55.2 %
6,360
156,1
20
933,2
32
16.7 %
Net Income Before
Nonrecurring Items Preferred
Dividends
Ending Common Equity
2007
$138,204
$810,292
= 17.06%
2006
$137,1
10
$720,5
30
=
19.03%
d. Profits in relation to sales, assets, and equity have all declined. Turnover has
remained stable. Overall, although absolute profits have increased in 2007,
compared with 2006, the profitability ratios show a decline
232
PROBLEM 8-6
a.
1 Net Profit
. Margin
Net Income Before Minority Share of
Earnings, Equity Income and Nonrecurring
Items
Net Sales
=
2007
$97,051
$1,600,000
2006
$51,419
$1,300,0
00
2005
$45,101
$1,200,0
00
= 6.07%
= 3.96%
= 3.76%
2 Return on
. Assets
Net Income Before Minority Share
of Earnings and Nonrecurring
Items
Average Total Assets
=
2007
$97,051
$1,440,600
2006
$51,419
$1,220,0
00
2005
$45,101
$1,180,0
00
= 6.74%
= 4.21%
= 3.82%
3 Total Asset
. Turnover
2007
$1,600,000
$1,440,600
Net Sales
Average Total
Assets
=
2006
$1,300,0
00
$1,220,0
00
2005
$1,200,0
00
$1,180,0
00
= 1.07
times
per year
= 1.02
times
per year
= 1.11 times
per year
4. DuPont Analysis
2007:
Return on
Assets
6.74%
=
=
Net Profit
Margin
6.07%
233
x
x
Total Asset
Turnover
1.11 times
2006:
2005:
4.24%
3.84%
=
=
3.96%*
3.76%*
x
x
1.07 times
1.02 times
*Rounding difference from the 4.21% and 3.82% computed in (2).
234
5 Operating Income
. Margin
Operating
Income
Net Sales
=
2007
1,600,0
$
00
(2) Net sales
Less:
Material and manufacturing
costs of products sold
Research and development
General and selling
740,00
0
90,000
600,00
0
1,430,0
$
00
170,00
$
0
(1) Operating income
(1) Divided by (2)
6.
Return on Operating
Assets
10.63%
2006
$1,300,000
2006
$ 1,200,0
00
97,500
576,00
0
71,400
465,00
0
$ 1,112,4
00
$ 87,600
7.50%
7.30%
624,000
78,000
500,500
$1,202,500
$
Operating Income
Average Operating
Assets
=
7.
Operating Asset Turnover
Net Sales
Average Operating Assets
2007
$170,000
$1,390,2
00
2006
$97,500
$1,160,0
00
2005
$87,600
$1,090,0
00
= 12.23%
Operating Income
Average Operating Assets
= 8.41%
= 8.04%
Net Sales
Average Operating
Assets
=
2007
$1,600,0
00
$1,390,2
00
2006
$1,300,0
00
$1,160,0
00
2005
$1,200,0
00
$1,090,0
00
= 1.15
times
= 1.12
times
= 1.10
times
235
8. DuPont Analysis with operating ratios
2007:
2006:
2005:
Return on
Assets
12.22%*
8.40%*
8.03%
=
=
=
=
Operating
Income Margin
10.63%
7.50%
7.30%
x
x
x
x
Operating Asset
Turnover
1.15
1.12
1.10
*Rounding difference from the 12.23%, 8.41%, and 8.04% computed in (6).
236
9.
Return on
Investment
Net Income Before Minority Share of Earnings and
Nonrecurring Items + [(Interest Expense) x (1 Tax
Rate)]
Average (Long-Term Liabilities) + Equity
=
Estimated tax rate:
2007
$ 62,049
(1) Provision for income taxes
(2) Earnings before income taxes and
159,10
minority equity
$
0
(1) (2)
39.00%
1 tax rate
61.00%
(3) Interest expense x (1 tax rate)
$19,000 x 61.00%
$18,200 x 59.00%
2006
$ 35,73
1
87,15
$
0
41.00
%
59.00
%
2005
$ 32,659
$ 77,760
42.00
%
58.00
%
11,590
10,73
8
$17,040 x 58.00%
9,883
(4) Earnings before minority equity
97,051
(3) + (4)
211,10
0
811,20
0
1,022,3
00
(6) Avg. stockholders equity
(5) + (6)
(B)
(A) (B)
10.
Return on Total
Equity
Net income etc.
=
121,8
00
790,1
00
911,9
00
214,00
0
770,00
0
984,00
0
10.63%
(5) Avg. long-term debt
45,101
108,64
1
(A)
51,41
9
62,15
7
6.82%
5.59%
54,984
Net Income Before Nonrecurring Items
Dividends on Redeemable Preferred
Stock
Average Total Equity
2007
$ 86,851
237
2006
$ 42,91
2005
$ 37,001
$ 811,20
0
=10.71
%
Average total equity
9
$ 790,1
00
=
5.43%
b. All ratios computed indicate a significant improvement in profitability.
238
$ 770,00
0
= 4.81
PROBLEM 8-7
a.
1 Net Profit
. Margin
2007
$171,115
$1,002,100
= 17.08%
2 Return on
. Assets
2007
$171,115
$839,000
= 20.40%
3 Total Asset
. Turnover
Net Income Before Minority Share of
Earnings, Equity Income and Nonrecurring
Items
Net Sales
=
2006
$163,4
97
$980,5
00
2005
$143,9
90
$900,0
00
=
16.67%
=
16.00%
Net Income Before Minority Share
of Earnings and Nonrecurring
Items
Average Total Assets
=
2006
$163,4
97
$770,0
00
2005
$143,9
90
$765,0
00
=
21.23%
=
18.82%
=
Net Sales
Average Total
Assets
2007
$1,002,100
$839,000
2006
$980,500
$770,000
2005
$900,000
$765,000
= 1.19 times
per year
= 1.27
times
per year
= 1.18
times
per year
4. DuPont Analysis
239
2007:
Return on
Assets
20.33%*
2006:
2005:
=
Net Profit Margin
=
17.08%
21.17%*
=
16.67%
18.88%*
=
16.00%
x
x
x
x
Total Asset
Turnover
1.19 times per
year
1.27 times per
year
1.18 times per
year
*Rounding difference from the 20.40%, 21.23%, and 18.82% computed in (2).
240
5.
Return on
Investment
Net Income Before Minority Share of Earnings and
Nonrecurring Items + [(Interest Expense) x (1 Tax
Rate)]
Average (Long-Term Liabilities) + Equity
=
Estimated tax rate:
2007
$ 116,4
73
$ 287,5
88
40.50
%
59.50
%
(1) Provision for income taxes
(2) Earnings before income taxes
Tax rate [(1) + (2)]
1 tax rate
(3) Interest expense x (1 tax rate)
$14,620 x 59.50%
$12,100 x 59.00%
$11,250 x 57.70%
7,139
6,491
171,1
15
179,8
14
(6) Average stockholders equity
6.
(B)
Return on Total
Equity
Net earnings
Average total equity
=
163,4
97
170,6
36
143,9
90
150,4
81
120,0
00
406,0
00
34.19
%
(A)
(5) Average long-term debt
(5) + (6)
2005
$ 105,5
60
$ 249,5
50
42.30
%
57.70
%
8,699
(4) Net earnings
(3) + (4)
2006
$ 113,6
16
$ 277,1
13
41.00
%
59.00
%
112,0
00
369,5
00
35.44
%
101,0
00
342,0
00
33.97
%
Net Income Before Nonrecurring Items
Dividends on Redeemable Preferred Stock
Average Total Equity
2007
$171,1
15
$406,0
00
2006
$163,4
97
$369,5
00
241
2005
$143,9
90
$342,0
00
=
42.15%
7.
Sales to Fixed
Assets
=
2007
$1,002,100
=
44.25%
Net Sales
Average Net Fixed
Assets
2006
$980,5
00
$281,0
00
= 3.31
2005
$900,0
00
$173,0
00
= 3.49
$302,500
=
42.10%
= 5.20
b. The ratios computed indicate a very profitable firm. Most ratios indicate a slight
reduction in profitability in 2007.
Sales to fixed assets has declined materially, but this is the only ratio for which the
trend appears to be negative.
PROBLEM 8-8
a. 1. Net Profit Margin
=
2007
$20,070 $8,028
Net Income Before Minority Share of Earnings,
Equity Income and Nonrecurring Items
Net Sales
$297,580
2006
$16,660
$6,830
$256,360
2005
$15,380
$6,229
$242,150
= 4.05%
= 3.83%
= 3.78%
2. Return on Assets
=
2007
$20,070 $8,028
$145,760
Net Income Before Minority Share of
Earnings and Nonrecurring Items
Total Assets
2006
$16,660
$6,830
$137,000
242
2005
$15,380
$6,229
$136,000
= 8.26%
3. Total Asset Turnover
2007
$297,580
$145,760
= 2.04 times
per year
= 7.18%
=
= 6.73%
Net Sales
Total Assets
2006
$256,3
60
$137,0
00
2005
$242,1
50
$136,0
00
= 1.87
times
per year
= 1.78
times
per year
243
4. DuPont Analysis
2007:
2006:
2005:
Return on
Assets
8.26%
7.16%*
6.73%
Net Profit Margin
=
=
=
=
Total Asset
Turnover
2.04 times
1.87 times
1.78 times
x
4.05%
3.83%
3.78%
x
x
x
*Rounding difference from the 7.18% computed in (2).
5. Operating Income Margin
2007
$26,380
$297,580
= 8.86%
Operating Income
Net Sales
=
2006
$22,86
0
$256,3
60
2005
$20,18
0
$242,1
50
=
8.92%
=
8.33%
6. Return on Operating Assets
=
End of Year Operating
Assets
Operating Income
2007
$26,380
$89,800 + $45,850
2006
$22,860
$84,500 +
$40,300
2005
$20,180
$83,100 +
$39,800
= 19.45%
= 18.32%
= 16.42%
7. Operating Assets Turnover
=
Net Sales
End of Year Operating
Assets
2007
$297,580
$89,800 + $45,850
2006
$256,360
$84,500 + $40,300
2005
$242,150
$83,100 + $39,800
= 2.19 times
per year
= 2.05 times
per year
= 1.97 times
per year
244
245
8. DuPont Analysis
2007:
2006:
2005:
Return on
Assets
19.40%*
18.29%*
16.41%*
=
=
=
=
Operating Income
Margin
8.86%
8.92%
8.33%
x
x
x
x
Operating Asset
Turnover
2.19 times
2.05 times
1.97 times
*Rounding difference from the 19.45%, 18.32%, and 16.42% computed in (6).
9. Gross Profit Margin
=
Gross Profit
Net Sales
2007
$91,580
$297,580
2006
$80,060
$256,360
2005
$76,180
$242,150
= 30.77%
= 31.23%
= 31.46%
b. Net profit margin and total asset turnover both improved. This resulted in a
substantial improvement to return on assets.
Operating income margin declined slightly in 2007 after a substantial improvement in
2006. Operating asset turnover improved each year. The result of the improvement
in operating income margin and operating asset turnover was a substantial
improvement in return on operating assets.
Gross profit margin declined slightly each year.
Overall profitability improved substantially over the three-year period.
246
PROBLEM 8-9
a. 1. Return on Assets
(A)
(B)
(A) (B)
2.
Net Income Before Minority Share of
Earnings and Nonrecurring Items
End of Year Total Assets
=
2007
$ 2,100,00
0
$ 2,600,00
0
7,000,00
0
100,000
10,000,0
00
$ 19,700,0
00
10.66%
Return on
Investment
=
2006
$ 1,950,00
0
$ 2,300,00
0
6,200,00
0
100,000
9,000,00
0
$ 17,600,0
00
11.08%
2005
$ 1,700,00
0
$ 2,200,00
0
5,800,00
0
100,000
8,300,00
0
$ 16,400,0
00
10.37%
Net Income Before Minority Share of Earnings and
Nonrecurring Items + [(Interest Expense) x (1 Tax
Rate)]
End of Year (Long-Term Liabilities + Equity)
Estimated tax rate:
2007
$ 1,500,00
0
3,600,00
0
2006
$ 1,450,00
0
3,400,00
0
2005
$ 1,050,00
0
2,750,00
0
Tax rate = (1) (2)
41.67%
42.65%
38.18%
1 tax rate
58.33%
57.35%
61.82%
(1) Provision for income taxes
(2) Income before Interest tax
(3) expense x (1 tax rate)
$800,000 x 58.33%
$600,000 x 57.35%
$550,000 x 61.82%
(4) Net income
$
466,640
$
344,100
$
$ 2,100,00
0
247
$ 1,950,00
0
340,010
$ 1,700,00
0
(3) + (4)
(A)
$ 2,566,64
0
Preferred stock
Common equity
(B)
$ 2,040,01
0
$ 7,000,00
0
100,000
10,000,0
00
$ 17,100,0
00
Long-term debt
$ 2,294,10
0
$ 6,200,00
0
100,000
9,000,00
0
$ 15,300,0
00
$ 5,800,00
0
100,000
8,300,00
0
$ 14,200,0
00
(A) (B)
3.
Return on Total
Equity
15.01%
14.99%
14.37%
Net Income Before Nonrecurring Items
Dividends on Redeemable Preferred Stock
Ending Total Equity
=
2007
$2,100,000
$100,000 + $10,000,000
2005
$1,700,000
$100,000 + $8,300,000
= 20.79%
4.
2006
$1,950,000
$100,000 + $9,000,000
= 21.43%
= 20.24%
Return on Common
Equity
=
Net Income Before
Nonrecurring Items Preferred
Dividends
Ending Common Equity
2007
$2,100,000 $14,000
$10,000,000
2006
$1,950,000 $14,000
$9,000,000
2005
$1,700,000 $14,000
$8,300,000
= 20.86%
= 21.51%
= 20.31%
b. Return on assets improved in 2006 and then declined in 2007. Return on investment
improved each year. Return on total equity improved and then declined. Return on
common equity improved and then declined.
In general, profitability has improved in 2006 over 2005 but was down slightly in
2007.
c. The use of long-term debt and preferred stock both benefited profitability.
248
Return on common equity is slightly more than return on total equity, indicating a
benefit from preferred stock.
Return on total equity is substantially higher than return on investment, indicating a
benefit from long-term debt.
249
PROBLEM 8-10
a.
Sales
$ 120,0
00
48,00
0
$ 72,00
0
Gross profit (40%)
Cost of goods sold (60%)
Beginning inventory
$ 10,00
0
100,0
00
$ 110,0
00
?
$ 72,00
0
+ Purchases
Total available
Ending inventory
Cost of goods sold
Ending inventory ($110,000 $72,000)
$ 38,00
0
b. If gross profit were 50%, the analysis would be as follows:
Sales
$ 120,0
00
60,00
0
$ 60,00
0
Gross profit (50%)
Cost of goods sold (50%)
Beginning inventory
$ 10,00
0
100,0
00
$ 110,0
00
50,00
0
$ 60,00
0
+ Purchases
Total available
Ending inventory
Cost of goods sold
250
Ending inventory ($110,000 $60,000)
$ 50,00
0
If gross profit were higher, the loss would be higher because ending inventory would be
estimated at $50,000 instead of $38,000.
251
PROBLEM 8-11
Net
Profit
Retained
Earnings
Total
Stockholders
Equity
a. A stock dividend is
declared and paid.
0
-
0
b. Merchandise is purchased
on credit.
0
0
0
c. Marketable securities are
sold above cost.
+
+
+
d. Accounts receivable are
collected.
0
0
0
e. A cash dividend is
declared and paid.
0
-
-
f. Treasury stock is
purchased and recorded
at cost.
0
0
-
g. Treasury stock is sold
above cost.
0
0
+
h. Common stock is sold.
0
0
+
i. A fixed asset is sold for
less than book value.
-
-
-
j. Bonds are converted into
common stock.
0
0
+
252
PROBLEM 8-12
a. 1. Net Profit Margin
=
Net Income Before Minority Share of Earnings
Equity Income and Nonrecurring Items
Net Sales
2007:
$72,70
0
$980,0
00
= 7.42%
2006:
$64,90
0
$960,0
00
= 6.76%
2005:
$57,80
0
$940,0
00
= 6.15%
2004:
$51,20
0
$900,0
00
= 5.69%
2003:
$44,90
0
$880,0
00
= 5.10%
2. Total Asset Turnover
=
Net Sales
Average Total Assets
2007:
$980,000
($859,000 +
$861,000)/2
= 1.14 times per year
2006:
$960,000
($861,000 +
$870,000)/2
= 1.11 times per year
2005:
$940,000
($870,000 +
= 1.08 times per year
253
$867,000)/2
2004:
2003:
$900,000
($867,000 +
$863,000)/2
= 1.04 times per year
Cannot compute average assets.
254
Year-End Balance Sheet Figures
2007:
$980,0
00
$859,0
00
= 1.14 times per year
2006:
$960,0
00
$861,0
00
= 1.11 times per year
2005:
$940,0
00
$870,0
00
= 1.08 times per year
2004:
$900,0
00
$867,0
00
= 1.04 times per year
2003:
$880,0
00
$863,0
00
= 1.02 times per year
3. Return on Assets
=
Net Income Before Minority Share of
Earnings and Nonrecurring Items
Average Total Assets
Average Balance Sheet Figures
2007:
$72,700
($859,000 +
$861,000)/2
= 8.45%
2006:
$64,900
($861,000 +
$870,000)/2
= 7.50%
2005:
$57,800
($870,000 +
$867,000)/2
= 6.66%
255
2004:
2003:
$51,200
($867,000 +
$863,000)/2
= 5.92%
Cannot compute average assets.
256
Year-End Balance Sheet Figures
2007:
$72,70
0
$859,0
00
= 8.46%
2006:
$64,90
0
$861,0
00
= 7.54%
2005:
$57,80
0
$870,0
00
= 6.64%
2004:
$51,20
0
$867,0
00
= 5.91%
2003:
$44,90
0
$863,0
00
= 5.20%
4. DuPont Return on Assets
=
Net Profit Margin x Total Asset Turnover
Average Balance Sheet Figures
2007:
2006:
2005:
2004:
2003:
7.42% x 1.14 times = 8.46%
6.76% x 1.11 times = 7.50%
6.15% x 1.08 times = 6.64%
5.69% x 1.04 times = 5.92%
Cannot compute average assets
Year-End Balance Sheet Figures
2007:
2006:
2005:
2004:
2003:
7.42% x 1.14 times = 8.46%
6.76% x 1.11 times = 7.50%
6.15% x 1.08 times = 6.64%
5.69% x 1.04 times = 5.92%
5.10% x 1.02 times = 5.20%
257
5. Operating Income Margin
=
Operating Income
Net Sales
2007:
$355,000
$240,000
$980,000
= 11.73%
2006:
$344,000
$239,000
$960,000
= 10.94%
2005:
$333,000
$238,000
$940,000
= 10.11%
2004:
$320,000
$239,000
$900,000
= 9.00%
2003:
$314,000
$235,000
$880,000
= 8.98%
6. Operating Asset Turnover
=
Net Sales
Average Operating Assets
2007:
$980,000
($859,000 $80,000 + $861,000
$85,000)/2
= 1.26 times per year
2006:
$960,000
($861,000 $85,000 + $870,000
$90,000)/2
= 1.23 times per year
2005:
$940,000
($870,000 $90,000 + $867,000
$95,000)/2
= 1.21 times per year
2004:
$900,000
($867,000 $95,000 + $863,000
$100,000)/2
258
= 1.17 times per year
2003:
Average assets cannot be computed.
259
Year-End Balance Sheet Figures
2007:
$980,000
$859,000
$80,000
= 1.26 times per year
2006:
$960,000
$861,000
$85,000
= 1.24 times per year
2005:
$940,000
$870,000
$90,000
= 1.21 times per year
2004:
$900,000
$867,000
$95,000
= 1.17 times per year
2003:
$880,000
$863,000
$100,000
7. Return on Operating Assets
= 1.15 times per year
=
Operating Income
Average Operating Assets
2007:
$355,000 $240,000
($859,000 $80,000 + $861,000
$85,000)/2
= 14.79%
2006:
$344,000 $239,000
($861,000 $85,000 + $870,000
$90,000)/2
= 13.50%
2005:
$333,000 $238,000
($870,000 $90,000 + $867,000
$95,000)/2
= 12.24%
2004:
2003:
$320,000 $239,000
($867,000 $95,000 + $863,000
$100,000)/2
Average assets cannot be computed.
260
= 10.55%
Year-End Balance Sheet Figures
2007:
$355,000
$240,000
$859,000
$80,000
2006:
$344,000
$239,000
$861,000
$85,000
= 13.53%
2005:
$333,000
$238,000
$870,000
$90,000
= 12.18%
2004:
$320,000
$239,000
$867,000
$95,000
= 10.49%
2003:
$314,000
$235,000
$863,000
$100,000
= 10.35%
= 14.76%
8. DuPont Return on Operating Assets
=
Operating Income Margin x
Operating Asset Turnover
Average Balance Sheet Figures
2007:
2006:
2005:
2004:
2003:
11.73% x 1.26 = 14.78%
10.94% x 1.23 = 13.46%
10.11% x 1.21 = 12.23%
9.00% x 1.17 = 10.53%
Average assets cannot be computed.
Year-End Balance Sheet Figures
2007:
2006:
2005:
2004:
2003:
11.73% x 1.26 = 14.78%
10.94% x 1.24 = 13.57%
10.11% x 1.21 = 12.23%
9.00% x 1.17 = 10.53%
8.98% x 1.15 = 10.33%
261
262
9. Sales to Fixed Assets
=
Net Sales
Average Net Fixed Assets
2007:
$980,000
($500,000 +
$491,000)/2
= 1.98
2006:
$960,000
($491,000 +
$485,000)/2
= 1.97
2005:
$940,000
($485,000 +
$479,000)/2
= 1.95
2004:
$900,000
($479,000 +
$470,000)/2
= 1.90
2003:
Average net fixed assets cannot be computed.
Year-End Balance Sheet Figures
2007:
$980,0
00
$500,0
00
= 1.96
2006:
$960,0
00
$491,0
00
= 1.96
2005:
$940,0
00
$485,0
00
= 1.94
2004:
$900,0
00
$479,0
00
= 1.88
263
2003:
$880,0
00
$470,0
00
= 1.87
264
Net Income Before Minority Share of Earnings and
10. Return on Investment = Nonrecurring Items + [Interest Expense x (1 Tax Rate)]
Average (Long-Term Liabilities + Equity)
Average Balance Sheet Figures
2007:
$72,700 + $6,500(1 0.33)
($859,000 $194,000 + $861,000
$195,500)/2
= 11.58%
2006:
$64,900 + $6,700(1 0.34)
($861,000 $195,500 + $870,000
$195,500)/2
= 10.35%
2005:
$57,800 + $8,000(1 0.34)
($870,000 $195,500 + $867,000
$195,000)/2
= 9.37%
2004:
$51,200 + $8,100(1 0.30)
($867,000 $195,000 + $863,000
$196,500)/2
= 8.50%
2003:
Average long-term liabilities + equity cannot be computed.
Year-End Balance Sheet Figures
2007:
$72,700 + $6,500(1
0.33)
$859,000 $194,000
= 11.59%
2006:
$64,900 + $6,700(1
0.34)
$861,000 $195,500
= 10.42%
2005:
$57,800 + $8,000(1
0.34)
$870,000 $195,500
= 9.35%
2004:
$51,200 + $8,100(1
0.30)
$867,000 $195,000
= 8.46%
265
2003:
$44,900 + $11,000(1
0.34)
$863,000 $196,500
= 7.83%
266
11. Return on Total Equity
=
Net Income Before Nonrecurring Items
Dividends on Redeemable Preferred Stock
Average Total Equity
Average Balance Sheet Figures
2007:
$72,700 $6,400
($520,000 +
$518,000)/2
= 12.77%
2006:
$64,900 $6,400
($518,000 +
$515,000)/2
= 11.33%
2005:
$57,800 $6,400
($515,000 +
$510,000)/2
= 10.03%
2004:
$51,200 $6,400
($510,000 +
$559,000)/2
= 8.38%
2003:
Average total equity cannot be computed.
Year-End Balance Sheet Figures
2007:
$72,700
$6,400
$520,000
= 12.75%
2006:
$64,900
$6,400
$518,000
= 11.29%
2005:
$57,800
$6,400
$515,000
= 9.98%
2004:
$51,200
$6,400
$510,000
= 8.78%
267
2003:
$44,90
0
$559,0
00
= 8.03%
268
12. Return on Common Equity
=
Net Income Before Nonrecurring
Items Preferred Dividends
Average Common Equity
Average Balance Sheet Figures
2007:
$72,700 $6,400 $6,300
($520,000 $70,000 + $518,000
$70,000)/2
= 13.36%
2006:
$64,900 $6,400 $6,300
($518,000 $70,000 + $515,000
$70,000)/2
= 11.69%
2005:
$57,800 $ 6,400 $6,300
($515,000 $70,000 + $510,000
$70,000)/2
= 10.19%
2004:
$51,200 $6,400 $6,300
($510,000 $70,000 + $559,000
$120,000)/2
2003:
Average common equity cannot be computed.
Year-End Balance Sheet Figures
2007:
$72,700 $6,400
$6,300
$520,000 $70,000
= 13.33%
2006:
$64,900 $6,400
$6,300
$518,000 $70,000
= 11.65%
2005:
$57,800 $ 6,400
$6,300
$515,000 $70,000
= 10.13%
2004:
$51,200 $6,400
$6,300
$510,000 $70,000
= 8.75%
2003:
$44,900 $10,800
= 7.77%
269
= 8.76%
$559,000
$120,000
270
13. Gross Profit Margin
=
Gross Profit
Net Sales
2007:
= 36.22%
2006:
$344,0
00
$960,0
00
= 35.83%
2005:
$333,0
00
$940,0
00
= 35.43%
2004:
$320,0
00
$900,0
00
= 35.56%
2005:
b.
$355,0
00
$980,0
00
$314,0
00
$880,0
00
= 35.68%
In general, the profitability appears to be very good and the trend is positive.
There was not a significant difference in results between using average balance
sheet figures and year-end figures. The year-end figure allowed for an additional
year was not a very profitable year in relation to subsequent years.
271
PROBLEM 8 - 13
a.
4
Interest expense represents a recurring item.
b.
5
Ideally, return on common equity will indicate the highest return. This is the
way it should be since the common equity holders take the most risk.
c.
3
A selling price increase would increase the gross profit.
d.
2
It would not be feasible to estimate administrative expenses by using gross
profit analysis.
e.
2
Total asset turnover measures the ability of the firm to generate sales
through the use of assets.
f.
4
Equity earnings can represent a problem in analyzing profitability because
equity earnings are not from operations.
g.
1
Intangibles are not considered to be an operating asset.
h.
4
Earnings based on percent of holdings by outside owners of consolidated
subsidiaries are termed minority earnings.
i.
1
Net profit margin x total asset turnover measures DuPont return on assets.
j.
4
If net profit margin declines and the total asset turnover declines, then the
return on assets cannot rise.
k.
3
A reason that equity earnings create a problem in analyzing profitability is
because equity earnings are usually less than the related cash flow.
l.
3
Usually the return on common equity will have the highest percent of the
ratios listed.
m.
4
Usually the return on total assets will have the lowest percent of the ratios
listed.
n.
4
Gain from selling land will be reported on the income statement.
o.
5
None of the above describes minority share of earnings.
p.
1
Purchase of land at year-end could cause return on assets to decline when
the net profit margin is increasing. The year-end purchase of land would not
have contributed to profits.
272
CASES
CASE 8-1 JEFFS SELF-SERVICE STATION
Profitability Planning
(This case is effective in illustrating the entity concept, return on investment, cash flow,
and the subjective nature of decision making.)
a. Indicated return on investment:
Average profit for 2007 and 2006:
2007:
2006:
Average
Depreciation as computed on the prior cost base
Depreciation as computed on the purchase cost
Adjusted profit
Tax, 50% rate
Net income
Return on Investment
=
$9,138
$70,000
=
$ 20,6
30
17,9
25
$ 38,5
55
$ 19,2
77
$ 1,000
(2,00
0)
18,277
9,139
$ 9,138
13.05%
b. Indicated return on investment if help were hired to operate the station:
Adjusted profit in part (a)
$ 18,27
7
10,00
0
$ 8,277
4,139
$ 4,138
Less cost of hired help
New adjusted profit
Tax, 50% rate
Net income
Return on Investment
=
$4,138
=
273
5.91%
$70,000
c. In (a), there is no salary expense. In (b), the salary expense for hired help of
$10,000 is deducted. This lowers the taxable income and taxes, giving a net effect
of $5,000. The rate of return in (a) must be higher to compensate for the opportunity
cost of the salary to the owner.
The difference between the rates of return is misleading in terms of judging the
investment. The records only reflect the actual cost, while disregarding opportunity
cost and personnel time not compensated. All costs need to be considered when
judging the investment.
d. Indicated cash flow:
Receipts:
Revenue
2008
$ 185,060
Outlays:
Cost of goods sold
Added inventory
Real estate and property taxes
Repairs and maintenance
Other expenses
Total outlays
160,180
10,000
1,100
1,470
680
$ 173,430
Net cash flow, excluding tax expense
11,630
Less taxes (a)
Net cash flow
$
9,815
1,815
(a) Cash flow prior to taxes
Add inventory
Deduct depreciation
Profit
Taxes
$ 11,630
10,000
(2,000)
$ 19,630
$ 9,815
e. Many other considerations can be discussed. Some of these include:
1. Future tax rate.
2. Psychological value of owning the business.
3. Can Mr. Dearden adequately serve as manager?
274
4. Will he be able to maintain or increase the business that was enjoyed by Mr.
Szabo?
5. Will there be appreciation in the value of the property?
6. Other investment alternatives.
f. This is a subjective question. Either a yes or no answer is acceptable. This
question should be discussed in relation to the above questions.
CASE 8-2 WORKING ON THE RAILROAD
(This case represents an opportunity to review segment reporting).
1.
Geographic Data
Horizontal Common-Size
For the Years ended December 31,
20
06
Canada
Australia
Mexico
Total operating revenues
200
4
15
3.9
12
6.2
N/
A
84.
7
15
7.6
Operating revenues:
United States
200
5
132.
2
115.
8
-----
100 %
.0
100
.0
-----
105.
2
126.
9
100
.0
100
.0
The best area by a substantial margin was the United States, followed by Canada.
Total operating revenues was up the most. It was aided by Australia which was not
part of the 2005 or 2004 operating revenues. Operating revenues in Mexico were
down substantially.
2.
Geographic Data
Horizontal Common-Size
For the Years ended December 31,
2006
275
2005
Long-lived assets located in:
United States
Canada
Australia
Mexico
Total long-lived assets
82.0
146.1
N/A
14.9
88.1
100.0
100.0
----100.0
100.0
Long-lived assets were increased very materially in Canada. They decreased
materially in the United States. The decrease was so substantial in Mexico that they
may be leaving Mexico.
3. The vertical common-size analysis for operating revenues is misleading because
Australia entered the picture in 2006, contributing 9.7% of operating revenues.
The United States is the major contributor, with over 70.0% of operating revenues.
The contribution of Mexico is declining.
4. The United States has over 80.0% of long-lived assets. There has been a material
increase in Canada and a material decrease in Mexico.
5. The United States represents the major contributor to operating revenues. Australia
entered in 2006 making a substantial contribution to operating revenues. Mexicos
contribution has declined substantially.
6. The United States has the majority of the long-lived assets. There was a material
increase in Canada and a material decrease in Mexico.
CASE 8-3 THE STORY OF STARBUCKS IN SEGMENTS
(This case represents an opportunity to review Starbucks in segments.)
a.
Starbucks
Vertical Common-Size
Fiscal 2006, Net Revenues
Unit
ed
Stat
es
Fiscal 2006
Net revenues
Company-operated retail
Specialty:
Internation
al
88.9
83.5
276
Global
CPG
Tota
l
84.5
Licensing
Foodservice and other
Total Specialty
Total net revenues
6.0
5.1
14.3
2.2
11.1
100.
0
16.5
100.
0
277
100.
0
----100.
0
100.
0
11.1
4.4
15.5
100.
0
b.
Starbucks
Horizontal Common-Size
Net Revenues from External Customers
Fiscal Year Ended
Net revenues from
external customers:
United States
Foreign countries
Total
Oct. 1,
2006
Oct. 2, 2005
Oct. 3, 2004
14
3.9
16
5.1
14
7.1
118.8
100.0
128.9
100.0
120.3
100.0
c.
Starbucks
Horizontal Common-Size
Long-Lived Assets
Fiscal Year Ended
Long-lived assets:
United States
Foreign countries
Total
Oct. 1,
2006
Oct. 2, 2005
Oct. 3, 2004
14
0.6
15
1.1
14
2.2
110.1
100.0
130.0
100.0
113.0
100.0
d. Comment on (a)
Most of the net revenues comes from the United States.
Licensing revenues represents a much bigger proportion in international than the
United States. Licensing represents 100.0% under Global CPG.
Comment on (b)
Net revenues were up materially more in foreign countries vs. the United States. Net
revenues increased materially in both the United States and foreign countries.
278
c. Comment on (c)
Long-lived assets increased much faster in foreign countries than in the United
States.
Long-lived assets increased materially in both the United States and foreign
countries.
279
CASE 8-4 SCOREBOARDS, ELECTRONIC DISPLAYS, ETC.
1.
2005
$15,660
$230,34
6
$17,74
5
$209,9
07
6.80%
Net Profit Margin
2004
8.45%
2.
Total Asset Turnover
$230,34
6
$151,462
$209,907
1.52 times
1.66 times
$126,236
3.
Return on Assets
$15,66
0
$151,4
62
$17,74
5
$126,2
36
10.34%
14.06%
$19,43
6
$230,3
46
$27,53
0
$209,9
07
8.44%
13.12%
4.
Operating income margin
5.
Return on Operating Assets
$19,436
$151,462 $2,621
- $1,101
$27,530
$126,236 $1,411
- $920
13.16%
22.22%
6.
280
Sales to Fixed Assets
$230,3
46
$31,05
3
$209,9
07
$25,09
6
7.42 times
8.36 times
281
7.
2005
$15,660 +
[$211 x (1
26.98%)]
$5,556 + $103,910
$17,745 +
[$478 x (1
38.07%)]
$4,675 + $86,264
$15,814.
07
$109,466
$18,041.
03
$90,939
14.45%
Return on Investment
2004
19.84%
8.
Return on Total Equity
$15,66
0
$103,9
10
$17,7
27
$86,2
64
15.07%
20.55
%
$15,66
0
$103,9
10
$17,7
27
$86,2
64
15.07%
20.55
%
$73,20
9
$230,3
46
$72,47
1
$209,9
07
31.78%
34.53%
9.
Return on Common Equity
10.
Gross Profit Margin
b. These ratios considered together indicate a material decline in profitability.
However, even after the material decline in profitability, the 2005 ratios indicate very
good profitability.
CASE 8-5 YAHOO SERVICES
a. 1.
282
2003
Net Profit Margin
2004
20.90%
$1,625,0
97
$5,931,6
54
$3,574,5
17
$9,178,2
01
0.27
times
3.
Return on Assets
$1,185,024 $437,966
$3,574,517
12.07%
2.
Total Asset Turnover
$343,172 $147,024
$1,625,097
0.39
times
$1,185,024 $437,966
+ $94,991
$9,178,201
4.11%
4.
Operating Income Margin
$343,172 $147,024
+ $47,652
$5,931,654
9.17%
$688,581
$3,574,5
17
18.19%
5.
Return on Operating Assets
$295,666
$1,625,09
7
19.26%
14.90%
$1,625,0
97
$449,512
$3,574,5
17
$531,696
3.62
Times
7.
Return on Investment
$688,581
$4,090,495 + 531,696
13.62%
6.
Sales to Fixed Assets
$295,666
$1,721,709 + $449,512
6.72
Times
$343,172
$147,024
$750,000 + $72,890
+
283
$1,185,024
$437,966
$65,875 + $750,000 +
$35,907 + 44,266 +
$37,478 + 4,363,490
3.75%
8.
Return on Total Equity
$7,101,446
9.34%
$839,553
$7,101,4
46
5.45%
9.
Gross Profit Margin
$237,879
$4,363,49
0
11.82%
$1,266,9
94
$1,625,0
97
$2,275,9
58
$3,574,5
17
77.96%
63.67%
284
b. Many of the ratios showed a material increase in profitability (net profit margin, total
asset turnover, return on assets, sales to fixed assets, return on investment, and
return on total equity).
Operating income margin improved slightly.
Gross profit margin declined materially.
The increase in revenues has been able to make up for the decline in gross profit
margin.
c. 1.
Yahoo Services
Consolidated Statements of Operations
Horizontal Common-Size
Revenues
Cost of revenues
Gross profit
Operating expenses:
Sales and marketing
Product development
General and administrative
Stock compensation expense
Amortization of intangibles
Total operating expenses
Income from operations
Other income, net
Income before income taxes, earnings in equity
interest, minority interests, and cumulative
effect of accounting change
Provision for income taxes
Earnings in equity interests
Minority interests in operations of consolidated
subsidiaries
Net income before cumulative effect of
accounting change
Cumulative effect of accounting change
Net income
285
Years Ended December 31,
2002
2003
2004
100.0 %
170.5 %
375.1 %
100.0
219.9
797.2
100.0
160.3
288.0
100.0
100.0
100.0
100.0
100.0
100.0
100.0
100.0
123.4
146.2
156.0
262.2
256.7
138.4
335.3
68.6
181.0
260.1
260.8
384.3
687.7
226.1
780.8
716.5
100.0
100.0
100.0
217.9
206.2
213.7
752.5
614.3
425.9
100.0
381.8
160.9
100.0
100.0
100.0
222.5
N/A
555.6
785.1
N/A
1,960.9
2. Material increase in all items
The biggest increase was in net income, but this increase was distorted by the
cumulative effect of accounting change in the base year
CASE 8-6 EAT AT MY REASTAURANT PROFITABILTY
(This case represents an opportunity to view the profitability of three restaurants.)
a. Net Profit Margin
Yum Brands has the highest net profit margin, followed by Panera Bread, and then
Starbucks. (Yum Brands and Panera Bread had the same net profit margin in 2005).
The trend was positive for Yum Brands and negative for Panera Bread and
Starbucks.
b. Return on Assets
Starbucks had the best return on assets. Yum Brands had a better return in 2006
than Panera Bread. Panera Bread had a better return in 2005 than did Yum Brands.
The trend was favorable for Yum Brands and Starbucks. The trend was negative for
Panera Bread.
c. Return on Total Equity
Yum Brands had a materially better return on total equity than did Panera Bread or
Starbucks. Starbucks was in second place followed by Panera Bread.
The trend was favorable for Yum Brands and Starbucks. The trend was negative for
Panera Bread.
d. Yum Brands is the more profitable firm in an investors view because of the
outstanding return on total equity. Starbucks would be considered in second place
considering its return on total equity and return on assets.
286
THOMSON ONE
1. This Thomson One exercise provides for a comment on the trend on selected
profitability ratios for Merck & Company.
2. This Thomson One exercise provides for comments on the trend in selected
profitability ratios for Anheuser-Busch and Molson Coors Brewing Company. It also
provides for a comparison of the Anheuser-Busch profitability ratios with Molson
Coors Brewing Company profitability ratios.
3. This Thomson One exercise provides for comments on the trend in selected
profitability ratios for Apple Computer, Dell Computer, and Hewlett-Packard. It also
provides for a comparison of the profitability ratios of Apple Computer, Dell
Computer, and Hewlett-Packard.
287