Hercules Company manufactures raingear. During 2014, Hercules Company decided to issue bonds at 8% interest and then used the cash to purchase a significant amount of treasury stock. The following information is available for Hercules Company.

2014 2013 Sales revenue $3,000,000 $3,000,000 Net income 800,000 900,000 Interest expense 120,000 50,000 Tax expense 166,000 190,000 Total assets 5,000,000 5,610,000 Average total assets 5,312,500 6,230,000 Total liabilities 2,000,000 1,200,000 Average total stockholders’ equity 3,322,500 5,250,000 Dividends paid on common stock 270,000 300,000 Dividends paid on preferred stock 40,000 40,000 Instructions

(a) Use the information above to calculate the following ratios for both years: (i) return on assets, (ii) return on common stockholders’ equity, (iii) payout ratio, (iv) debt to assets ratio, and (v) times interest earned.

(b) Referring to your findings in part (a), discuss the changes in the company’s profitability from 2013 to 2014.

(c) Referring to your findings in part (a), discuss the changes in the company’s solvency from 2013 to 2014.

(d) Based on your findings in (b), was the decision to issue debt to purchase common stock a wise one?

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