5. Profitability ratios 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 Dernham Inc. and make comments on its second-year performance as compared with its first-year performance. The following shows Dernham Inc.'s income statement for the last two years. The company had assets of $8,225 million in the first year and $13,157 million in the second year. Common equity was equal to $4,375 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. Dernham Inc. Income Statement For the Year Ending on December 31 (Millions of dollars) Year 2 Year 1 Net Sales 4,445 3,500 Operating costs except depreciation and amortization 1,365 1,268 Depreciation and amortization 222 140 Total Operating Costs 1,587 1,400 Operating Income (or EBIT) 2,856 2,092 Dernham Inc. Income Statement For the Year Ending on December 31 (Millions of dollars) Year 2 Year 1 Net Sales 4,445 3,500 Operating costs except depreciation and amortization 1,365 1,268 Depreciation and amortization 222 140 Total Operating Costs 1,587 1,408 Operating Income (or EBIT) 2,858 2,092 Less: Interest 286 272 Earnings before taxes (EBT) 2,572 1,820 Less: Taxes (25%) 455 Net Income 1,929 1,365 Calculate the profitability ratios of Dernham Inc. in the following table. Convert all calculations to a percentage rounded to two decimal places. Ratio Value Year 21 Year 11 Value Year 2 43.40% Ratio Year 1 Operating margin 59.77% Profit margin Return on total assets 16.60% Return on common equity 31.20% Basic earning power 21.72% D 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. If a company has a profit margin of 10%, it means that the company earned a net income of $0.10 for each dollar of sales. If a company's operating margin increases but its profit margin decreases, it could mean that the company paid more in interest or taxes. An increase in a company's eamings means that the profit margin is increasing. Decision makers and analysts look deeply into profitability ratios to identify trends in a company's profitability. Profitability ratios give insights in 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. If a company has a profit margin of 10%, it means that the company earned a net income of $0.10 for each dollar of sales. 4 If a company's operating margin increases but its profit margin decreases, it could mean that the company paid more in interest or taxes. An increase in a company's earnings means that the profit margin is increasing. If a company issues new common shares but its net income does not increase, return on common equity will increase. Grade It Now Save & Continue
