Question #5
Reading: Reading 13 Integration of Financial Statement Analysis Techniques
PDF File: Reading 13 Integration of Financial Statement Analysis Techniques.pdf
Page: 2
Status: Correct
Correct Answer: A
Question
Express Delivery Inc. (EDI) reported the following year-end data: Depreciation expense $30 million Net income $30 million Total assets $535 million Shareholder's equity $150 million Effective tax rate 35 percent Last year EDI purchased a fleet of delivery vehicles for $140 million. For the first year, straight-line depreciation was used assuming a depreciable life of 7 years with no salvage value. However, at year-end EDI's management determined that assumptions of a useful life of 5 years with a salvage value of 10 percent of the original value were more appropriate. How would the return on assets (RO
Answer Choices:
A. ROA 5.0% and ROE 18.2%
B. ROA 5.7% and ROE 19.5%
Explanation
The reported ROA and ROE are 5.6% (30/535) and 20.0% (30/150) respectively. Under the
new depreciation assumptions, depreciation expense would be (140-14)/5 = 25.2 million.
Under the original assumptions depreciation of the fleet was 20 million. Therefore
depreciation increases by 5.2 million. With the change in depreciation methods EDI would
have reported:
Depreciation expense
$35.20 million
(30 + 5.2)
Net income
$26.62 million
(30 − (5.2 × (1-0.35)))
Total assets
$529.80 million
(535 − 5.2 )
Shareholder's equity
$146.62 million
(150 − 3.38)
Note that assets would have been lower by $5.2 million due to the new depreciation
assumptions and shareholder's equity by $3.38 million (5.2 × (1 − 0.35)) due to lower
retained earnings. Tax liabilities would have fallen by $1.82 million to balance the $5.2
million reduction in assets. Therefore, ROA would have been 5.0% (26.62 / 529.80) and
ROE would have been 18.16% (26.62 / 146.62).