University:
California State University, Northridge
Course:
ACCT 230 | Introduction to Managerial Accounting
Academic year:

2024
Views:

338

Pages:

15
Author:

ekrasitrj5

Chapter 14 “How Well Am I Doing?” Financial Statement Analysis 14-40 Learning Objective 2 Compute and interpret financial ratios that would be useful to a common stockholder. 14-41 Ratio Analysis – The Common Stockholder NORTON CORPORATION The ratios that are of the most interest to stockholders include those ratios that focus on net income, dividends, and stockholders’ equities. 2009 Number of common shares outstanding Beginning of year End of year Net income 17,000 27,400 $ 53,690 Stockholders' equity Beginning of year 180,000 End of year 234,390 Dividends per share Dec. 31 market price per share Interest expense 2 20 7,300 Total assets Beginning of year 300,000 End of year 346,390 14-42 Earnings Per Share Earnings per Share = Net Income – Preferred Dividends Average Number of Common Shares Outstanding Whenever a ratio divides an income statement balance by a balance sheet balance, the average for the year is used in the denominator. Earnings form the basis for dividend payments and future increases in the value of shares of stock. 14-43 Earnings Per Share Earnings per Share = Earnings per Share = Net Income – Preferred Dividends Average Number of Common Shares Outstanding $53,690 – $0 (17,000 + 27,400)/2 = $2.42 This measure indicates how much income was earned for each share of common stock outstanding. 14-44 Price-Earnings Ratio Price-Earnings Ratio Price-Earnings Ratio = = Market Price Per Share Earnings Per Share $20.00 $2.42 = 8.26 times A higher price-earnings ratio means that investors are willing to pay a premium for a company’s stock because of optimistic future growth prospects. 14-45 Dividend Payout Ratio Dividend Payout Ratio Dividend Payout Ratio = = Dividends Per Share Earnings Per Share $2.00 $2.42 = 82.6% This ratio gauges the portion of current earnings being paid out in dividends. Investors seeking dividends (market price growth) would like this ratio to be large (small). 14-46 Dividend Yield Ratio Dividend Yield Ratio Dividend Yield Ratio = = Dividends Per Share Market Price Per Share $2.00 $20.00 = 10.00% This ratio identifies the return, in terms of cash dividends, on the current market price of the stock. 14-47 Return on Total Assets Return on = Total Assets Net Income + [Interest Expense × (1 – Tax Rate)] Average Total Assets Return on = Total Assets $53,690 + [$7,300 × (1 – .30)] = 18.19% ($300,000 + $346,390) ÷ 2 Adding interest expense back to net income enables the return on assets to be compared for companies with different amounts of debt or over time for a single company that has changed its mix of debt and equity. 14-48 Return on Common Stockholders’ Equity Return on Common = Net Income – Preferred Dividends Stockholders’ Equity Average Stockholders’ Equity Return on Common = $53,690 – $0 = 25.91% Stockholders’ Equity ($180,000 + $234,390) ÷ 2 This measure indicates how well the company used the owners’ investments to earn income. 14-49 Financial Leverage Financial leverage results from the difference between the rate of return the company earns on investments in its own assets and the rate of return that the company must pay its creditors. Return on investment in > assets Fixed rate of return on borrowed funds Positive = financial leverage Return on investment in < assets Fixed rate of return on borrowed funds Negative = financial leverage 14-50 Quick Check  Which of the following statements is true? a. Negative financial leverage is when the fixed return to a company’s creditors and preferred stockholders is greater than the return on total assets. b. Positive financial leverage is when the fixed return to a company’s creditors and preferred stockholders is greater than the return on total assets. c. Financial leverage is the expression of several years’ financial data in percentage form in terms of a base year. 14-51 Quick Check  Which of the following statements is true? a. Negative financial leverage is when the fixed return to a company’s creditors and preferred stockholders is greater than the return on total assets. b. Positive financial leverage is when the fixed return to a company’s creditors and preferred stockholders is greater than the return on total assets. c. Financial leverage is the expression of several years’ financial data in percentage form in terms of a base year. 14-52 Book Value Per Share Book Value per Share Book Value per Share = Common Stockholders’ Equity Number of Common Shares Outstanding = $234,390 27,400 = $ 8.55 This ratio measures the amount that would be distributed to holders of each share of common stock if all assets were sold at their balance sheet carrying amounts after all creditors were paid off. 14-53 Book Value Per Share Book Value per Share Book Value per Share = Common Stockholders’ Equity Number of Common Shares Outstanding = $234,390 27,400 = $ 8.55 Notice that the book value per share of $8.55 does not equal the market value per share of $20. This is because the market price reflects expectations about future earnings and dividends, whereas the book value per share is based on historical cost.