Gadget Twin Inc. Income Statement For the Year Ending on December 31 (Millions of dollars) Year 2 Year 1
Net Sales 6,350 5,000
Operating costs except depreciation and amortization 1,120 1,040
Depreciation and amortization 318 200
Total Operating Costs 1,438 1,240
Operating Income (or EBIT) 4,912 3,760
Less: Interest 663 395
Earnings before taxes (EBT) 4,249 3,365
Less: Taxes (40%) 1,700 1,346
Net Income 2,549 2,019
Calculate the profitability ratios of Gadget Twin Inc. in the following table. Convert all calculations to a percentage rounded to two decimal places.
Ratio Value
Year 2 Year 1
Operating margin 75.20%
Profit margin 40.14%
Return on total assets 17.18%
Return on common equity 32.30%
Basic earning power 26.13%
Decision makers and analysts look deeply into profitability ratios to identify trends in a company’s profitability. Profitability ratios give insights into both the survivability of a company and the benefits that shareholders receive. Identify which of the following statements are true about profitability ratios. Check all that apply.
a) A higher operating margin than the industry average indicates either lower operating costs, higher product pricing, or both.
b) If a company’s operating margin increases but its profit margin decreases, it could mean that the company paid more in interest or taxes.
c) An increase in the return on assets ratio implies an increase in the assets a firm owns.
d) If a company issues new common shares but its net income does not increase, return on common equity will increase.