Compute (a) profit margin and (b) return on total assets.

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Understand the Problem

The question is asking to compute the profit margin and the return on total assets for Edison Company based on the provided financial data. This involves using the formulas for profit margin and return on assets, which require the net income, net sales, and total assets values given.

Answer

Profit Margin: $20\%$, Return on Total Assets: $25\%$
Answer for screen readers
  • Profit Margin: $20%$
  • Return on Total Assets: $25%$

Steps to Solve

  1. Understand the formulas

The profit margin is calculated as:

$$ \text{Profit Margin} = \frac{\text{Net Income}}{\text{Net Sales}} $$

The return on total assets (ROA) is calculated as:

$$ \text{ROA} = \frac{\text{Net Income}}{\text{Average Total Assets}} $$

  1. Gather the data

From the provided information:

  • Net sales = $87,000
  • Net income = $17,400
  • Beginning balance of total assets = $62,000
  • Ending balance of total assets = $77,200
  1. Calculate average total assets

The average total assets can be calculated as:

$$ \text{Average Total Assets} = \frac{\text{Beginning Total Assets} + \text{Ending Total Assets}}{2} $$

Substituting the values:

$$ \text{Average Total Assets} = \frac{62,000 + 77,200}{2} = \frac{139,200}{2} = 69,600 $$

  1. Calculate the profit margin

Now, substituting the values into the profit margin formula:

$$ \text{Profit Margin} = \frac{17,400}{87,000} \approx 0.2 $$

To express it as a percentage, multiply by 100:

$$ \text{Profit Margin} = 0.2 \times 100 = 20% $$

  1. Calculate the return on total assets

Using the calculated average total assets, we can now find ROA:

$$ \text{ROA} = \frac{17,400}{69,600} \approx 0.25 $$

Again, converting it to a percentage:

$$ \text{ROA} = 0.25 \times 100 = 25% $$

  • Profit Margin: $20%$
  • Return on Total Assets: $25%$

More Information

The profit margin indicates that Edison Company keeps 20 cents of profit for every dollar of sales, while the return on total assets shows that for every dollar in assets, the company generates a return of 25 cents.

Tips

  • Forgetting to average total assets by using only one balance.
  • Not converting ratios to percentages when needed.

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