The following information is available for the Memphis and Billings companies: Memphis Billings
Sales $1,500,000 $1,500,000
Cost of goods sold 1,050,000 1,125,000
Operating expenses 350,000 250,000
Total assets 1,800,000 1,800,000
Stockholders’ equity 720,000 720,000

Required
a. Prepare a common size income statement for each company.
b. Compute the return on assets and return on equity for each company.
c. Which company is more profitable from the stockholders’ perspective?
d. One company is a high-end retailer, and the other operates a discount store. Which is the discounter?

(a) An income statement was prepared for Memphis and Billing Companies (b) The ROA for Memphis is = 5.6% while for Billing is  6.9%.

The ROE for Memphis is 13.9% for Billings it is 17.4%

(c) The billing company is more profitable because from the view from the stockholders it has a higher return on equity

(d) The Memphis company is the discounter

Explanation:

Solution

Given that:

(A) The Income statement for Memphis and Billing companies

                         Common size Income statement

                                  Memphis        %           Billings             %

Sales                          15,00,000    100          15,00,000        100

The cost of Goods    10,50,000     70           11,25,000        75.00

The Gross profit        4,50,000      30            3,75,000         25.0

Operating expenses  3,50,000     23.3        2,50,00            16.7

Net income                 1,00.000      6.7          1,25,000           8.3

(B) We compute the return assets which is given below:

The return on assets is = The net income/Total assets * 100

For Memphis,

The return on assets is = 5.6% ($100,000/18,00,000) * 100

Fro Billings,

The return on assets = 6.9% ($ 125,000/18,00,000) * 100

For the return on equity we have the following given below:

Return on equity is =Net income/Stockholder's equity * 100

For Memphis,

The return on equity =13.9% ($100,000/720,000) * 100

Fr Billings,

The return on equity =  17.4% ($125,000/720,000) * 100

(C) The Billing company is more profitable because it has a higher  return on rate on equity than that of the Memphis company.

(D) The Memphis has a lower  Net profit margin of 6.7% therefore it is the discounter.

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