PROBLEM 43 EVALUATING PROFITABILITY Last year Davies Inc had

PROBLEM 4-3 EVALUATING PROFITABILITY Last year, Davies Inc. had sales of S400,000 with a cost of goods sold of $112,000. The firm\'s operating expenses were $130,000, and its increase in retained earnings was S58,000. There are currently 22,000 common stock shares outstanding and the firm pays a S1.60 dividend per share. a. Assuming the firm\'s earnings are taxed at 34 percent, construct the firm\'s income statement. b. Compute the firm\'s operating profit margin. c. What was the times interest earned? DATA Sales Cost of goods sold Operating expenses Increase in Common stock outstanding Dividend per share Tax rate S400,000 112,000 130,000 58,000 retained earnings 22,000 shares S1.60 34% SOLUTION a. Assuming the firm\'s earnings are taxed at 34 percent, construct the firm\'s income statement Income Statement: Net sales Cost of goods sold Gross profit Operating expenses Operating income Interest expense Income before taxes Tax Net income b. Compute the firm\'s operating profit margin. Operating profit margin c. What was the times interest earned? Times interest earned

Solution

Income statement -

Working Note - 1

suppose interest expense = x

(operating income - x)*(1-0.34) = dividend per share + retained earnings

(158000 - x)*0.66 = 22000*1.6 + 58000

x = 158000 - (35200+58000)/0.66

x = 158000 - 141212.12 or 141212

= 16788

(b) Computation of firm\'s operating profit margin -

operating prodit margin = operating profit / Net sales * 100

= 158000/400000*100

= 39.5%

operating profir = Net sales - COGS - Operating expense

(c) Computation of Times interest earned -

Times interest earned = operating income / Interest expense

= 158000/16788

= 9.41

In case of any doubt please comment.

	Income statement		Remarks
A	Net sales	400000	given
B	Cost of goods sold	112000	given
C	Gross profit (A-B)	288000
D	operating expense	130000	given
E	operating income(C-D)	158000
F	interest expense	16788	Working Note 1
G	income before tax(E-F)	141212
H	tax @ 34% (G*34%)	48012
I	EAT (G-H)	93200
J	dividend paid	35200	given
K	retained earnings	58000	given