# Profitability Ratios

### Profitability Ratios1.

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### Compute the profitability ratios, including the a and b components (DuPont Methods) of ratios 2 and 3 as shown in the textbook. The profitability ratios should be shown for all three years.

2. Write a brief one-paragraph description of any trends that appear to have taken place over the three-year time period.

3. In examining the income statement in Figure 1, note that there was an extraordinary loss of $170,000 in 2006. This might have represented uninsured losses from a fire, a lawsuit settlement, etc. It probably does not represent a recurring event or affect the earnings capability of the firm. For that reason, the astute financial analyst might add back in the extraordinary loss to gauge the true operating earnings of the firm. Since it was a tax-deductible item, we must first multiply by (1-tax rate) before adding it back in.* The tax rate was 35 percent for the year.*

$170,000 Extraordinary loss

.65 (1-tax rate)

$110,500 Aftertax addition to profits from eliminating

the extraordinary loss from net income

The more representative net income number for 2003 would now be:

Initially reported (Figure 1) $200,318

Adjustment for extraordinary loss being eliminated +110,500

Adjusted net income $310,818

Based on the adjusted net income figure of $310,818, re compute the profitability ratios for 2006 (include part a and b for ratios 2 and 3).

4. Now with the adjusted net income numbers as part of the ratios for 2006, write a brief one-paragraph description of trends that appear to have taken place over the three-year time period (refer back to the data in Question 1 for 2004 and 2005).

5. Once again, using the revised profitability ratios for 2006 that you

developed in Question 3, write a complete one paragraph analysis of the

company’s profitability ratios compared to the industry ratios (figure 3).

Make sure to include asset turnover and debt to total assets as supplemental

material in your analysis.

6. Harrod’s has a superior sales to total assets ratio compared to the industry.

For 2006, compute ratios 4, 6 and 7 as described in the text and compare

them to industry data to see why this is so. Write a brief one-paragraph

description of the results. Note: for ratio 4, only half the sales are on credit

terms.

7. Conclusion: Based on your analysis in answering Questions 4 and 5, do you

hink that Becky Harrod has a legitimate complaint about being charged 2½

percent over prime instead of one percent over prime? There is no absolute

right answer to this question, but use your best judgment