Answer solution be sure to put any written parts into your own words before submission.

. The annual sales for Salco Inc. were $4.5 million last year. The firms end-of-year balance sheet was as follows: Current assets $ 500,000 Liabilities $1,000,000 Net fixed assets 1,500,000 Owners equity 1,000,000 $2,000,000 $2,000,000 The firms income statement for the year was as follows: Sales $ 4,500,000 Less cost of goods sold (3,500,000) Gross profit $ 1,000,000 Less operating expenses (500,000) Operating income $ 500,000 Less interest expense (100,000) Earnings before taxes $ 400,000 Less taxes (50%) (200,000) Net income $ 200,000 a. Calculate Salcos total asset turnover, operating profit margin, and operating return on assets. b. Salco plans to renovate one of its plants, which will require an added investment in plant and equipment of $1 million. The firm will maintain its present debt ratio of .5 when financing the new investment and expects sales to remain constant. The operating profit margin will rise to 13 percent. What will be the new operating return on assets for Salco after the plants renovation? c. Given that the plant renovation in part b occurs and Salcos interest expense rises by $50,000 per year, what will be the return earned on the common stockholders investment? Compare this rate of return with that earned before the renovation.

a.

Salcos total asset turnover, operating profit margin, and operating return on assets. Total Asset Turnover = = = Operating Profit Margin = = = Operating return on assets = = = Sales Total Assets $4,500,000 $2,000,000 2.25 times Operating Income Sales $500,000 $4,500,000 11.11% Operating Income Total Assets $500,000 $2,000,000 25%

or

= =

Operating Income Sales x Sales Total Assets .1111 X 2.25 = 25%

b.

The new operating return on assets for Salco after the plant renovation: Operating return on assets = = Operating Income Sales .13 x $4,500,000 $3,000,000 x Sales Total Assets

c.

= .13 x 1.5 = 19.5% Return earned on the common stockholders investment: Post-Renovation Analysis: Return on common equity = = = Net Income Available to Common Common Equity $217,500 $1,000,000 + $500,000 14.5%

Net Income Available to Common following the renovation was calculated as follows: Operating Income (.13 x $4.5m) Less: Interest ($100,000 + $50,000) Earnings Before Taxes Less: Taxes (50%) Net Income Available to Common Pre-renovation Analysis: The pre-renovation rate of return on common equity (ROCE) is calculated as follows: ROCE = Comparative Analysis: A comparison of the two rates of return would argue that the renovation not be undertaken. However, since investments in fixed assets generally produce cash flows over many years, it is not appropriate to base decisions about their acquisition on a single years ratios. There are additional problems with this approach to fixed asset decision making which we will discover when we discuss capital budgeting in a later chapter. $200,000 $1,000,000 = 20% $ 585,000 (150,000) 435,000 (217,500) $ 217,500