13 BP Front Beam Lighting Company has ... [FREE SOLUTION]

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Foundations Of Financial Management

Stanley B. Block, Geoffrey A. Hirt, Bartley Danielsen

Business Studies

16th Edition 路 768 pages

ISBN: 9781259277160

Chapter 2: 13 BP (page 80)

Front Beam Lighting Company has the following ratios compared to its industry for last year:
Front Beam Lighting
Industry
Return on assets
12%
5%
Return on equity
16%
20%
Explain why the return-on-equity ratio is so much less favorable than the return on-assets ratio compared to the industry. No numbers are necessary; a one- sentence answer is all that is required.

Short Answer

Expert verified

Because Front Beam has a lower debt/total assets ratio than the industry.

Step by step solution

Return on asset

Return on assets is computed by dividing the net income by the company's total assets.It shows the profitability of the company in relation to its total assets of the company.

Return on equity

Per the Dupont analysis, return on equity is computed as follows:

$R e t u r n o n a s s e t = R e t u r n o n e q u i t y 脳 (1 - \frac{D e b t}{A s s e t})$

If the debt-asset ratio is less, the return on equity is also less and vice-versa

FrontBeam's Debt/Asset Ratio

$\frac{Debt}{Asset} = 1 - \frac{R e t u r n o n A s s e t}{R e t u r n o n E q u i t y} = 1 - \frac{12 %}{16 %} = 0.25 = 25 %$

Industry's Debt/Asset Ratio

$\frac{Debt}{Asset} = 1 - \frac{R e t u r n o n A s s e t}{R e t u r n o n E q u i t y} = 1 - \frac{5 %}{20 %} = 0.75 = 75 %$

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Taxes	Earning per share
Share Outstanding	Earning before taxes
Interest Expense	Cost of goods sold
Depreciation Expense	Earning after taxes
Preferred Stcok dividends	Earning available to common stockholders
Sales	Selling and administrative expense
Gross profit

Sales	$900,000
Shares outstanding	50,000
Cost of goods sold	400,000
Interest expenses	40,000
Selling and administration expenses	60,000
Depreciation expenses	20,000
Preferred stock dividend	80,000
Taxes	50,000

Stud Clothier
Balance sheet 20X1
Assets		Liabilities and Equity
Cash	\)60,000	Account payable	\(220,000
Account receivable	240,000	Accrued taxes	30,000
Inventory	350,000	Bonds payable (long term)	150,000
Plant and equipment	410,000	Common stock	80,000
		Paid in capital	200,000
		Retained earnings	380,000
Total assets	\)1,060,000	Total LIbilities and Equity	$1,060,000

Times mirror and glass company
Sales	\)126,000
Less: Cost of goods sold	93,000
Gross profit	\(33,000
Less: selling and administrative expenses	11,000
Lease Expenses	4,000
Operating profit*	\)18,000
Less: Interest expenses	3,000
Earning before taxes	\(15,000
Less: Taxes (30%)	4,500
Earning after taxes	\)10,500

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Short Answer

Step by step solution

Return on asset

Return on equity

FrontBeam's Debt/Asset Ratio

Industry's Debt/Asset Ratio

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	Front Beam Lighting	Industry
Return on assets	12%	5%
Return on equity	16%	20%