The relationship between financial leverage and profitabilit

The relationship between financial leverage and profitability Pelican Paper, Inc., and Timberland Forest, Inc., are rivals in the manufacture of craft papers. Some financial statement values for each compan EE Use them in a ratio analysis that compares the firmns, financial leverage and profitability. a. Calculate the following debt and coverage ratios for the tvo companies. Discuss their financial risk and ability to cover the costs in relation to each other (1) Debt ratio (2) Times interest eamed ratio b. Calculate the following profitability ratios for the two companies. Discuss their profitability relative to each other (1) Operating profit margin (2) Net profit margin (3) Return on total assets (4) Return on common equity c. In what way has the larger debt of Timberland Forest made it more profitable than Pelican Paper? What are the risks that Timberland\'s investors undertake when they choose to purchase its stock instead of P . The debt ratio for Pelican is 1 % (Round to one decimal place ) Data Table Click on the icon located on the top-right corner of the data table below in order to copy its contents into a spreadsheet.) Item Pelican Paper, Inc. Timberland Forest, Inc Total assets Total equity (all common) Total debt Annual interest Total sales EBIT Earnings available for S9,500,000 8,600,000 900,000 90,000 25,000,000 6,250,000 S9,500,000 4,400,000 5,100,000 510,000 25,000,000 6,250,000 Enter your answer in the answer box and then click Check Answer common stockholders 3,690,000 3,450,000

Solution

1

Debt ratio = Total Debt / Total Assets

Pelican

Timberland

Total debt (A)

                  900,000

                               5,100,000

Total Assets (B)

              9,500,000

                               9,500,000

Debt ratio (C=A/B)

9%

54%

2

Times interest earned ratio = EBIT/Interest expense

Pelican

Timberland

EBIT (A)

              6,250,000

                               6,250,000

Interest expense(B)

                    90,000

                                  510,000

Times interest earned ratio (C=A/B)

                      69.44

                                      12.25

Profitability ratios

Pelican

Timberland

EBIT (A)

              6,250,000

                               6,250,000

Total Sales (B)

            25,000,000

                             25,000,000

Total Assets (C)

              9,500,000

                               9,500,000

Total Equity (D)

              8,600,000

                              4,400,000

Interest expense (D)

                    90,000

                                  510,000

Operating profits (E) (EBIT)

              6,250,000

                               6,250,000

Net profits =EBIT-Interest expense (F=A-D)

              6,160,000

                               5,740,000

1

Operating profit margin =Operating profits/Total sales
G=E/B

25.00%

25.00%

2

Net profit margin (H=F/B)

24.64%

22.96%

3

Return on total assets = Net profit/Total assets (I = F/C)

64.84%

60.42%

4

Return on common equity =Net profit/Total equity (J = F/D)

71.63%

130.45%

1	Debt ratio = Total Debt / Total Assets
		Pelican	Timberland
	Total debt (A)	900,000	5,100,000
	Total Assets (B)	9,500,000	9,500,000
	Debt ratio (C=A/B)	9%	54%
2	Times interest earned ratio = EBIT/Interest expense
		Pelican	Timberland
	EBIT (A)	6,250,000	6,250,000
	Interest expense(B)	90,000	510,000
	Times interest earned ratio (C=A/B)	69.44	12.25
	Profitability ratios
		Pelican	Timberland
	EBIT (A)	6,250,000	6,250,000
	Total Sales (B)	25,000,000	25,000,000
	Total Assets (C)	9,500,000	9,500,000
	Total Equity (D)	8,600,000	4,400,000
	Interest expense (D)	90,000	510,000
	Operating profits (E) (EBIT)	6,250,000	6,250,000
	Net profits =EBIT-Interest expense (F=A-D)	6,160,000	5,740,000
1	Operating profit margin =Operating profits/Total sales G=E/B	25.00%	25.00%
2	Net profit margin (H=F/B)	24.64%	22.96%
3	Return on total assets = Net profit/Total assets (I = F/C)	64.84%	60.42%
4	Return on common equity =Net profit/Total equity (J = F/D)	71.63%	130.45%