Question #22
Reading: Reading 13 Integration of Financial Statement Analysis Techniques
PDF File: Reading 13 Integration of Financial Statement Analysis Techniques.pdf
Page: 12
Status: Correct
Correct Answer: A
Question
Star Chemical Inc. (SCI) reported the following year-end data: Depreciation expense $25 million Net income $35 million Dividends $10 million Total assets $250 million Shareholder's equity $195 million Effective tax rate 35 percent SCI also reported that it changed from an accelerated depreciation method to straight line depreciation. The change resulted in a decrease in depreciation expense of $5 million. Management felt that the change "would not have a material effect on financial performance measures." Ignoring deferred taxes, what are the return on assets (RO
Answer Choices:
A. ROA is 12.96% and ROE is 16.56%
B. ROA is 13.30% and ROE is 17.05%
Explanation
The change in depreciation methods results in net income increasing by $3.25 million ($5
million × (1-0.35)) and total assets increasing by $5 million. Without the change in
depreciation methods SCI would have reported:
Depreciation expense
$30 million
($25 + $5)
Net income
$31.75 million
($35 – $3.25)
Total assets
$245 million
($250 – $5)
Shareholder's equity
$191.75 million
($195 − $3.25)
Note that assets would have been lower by $5 million due to the accelerated depreciation
and equity would be lower by $3.25 million ($5 × (1 − 0.35)) due to lower retained earnings.
In order to balance the $5 million reduction in assets, equity will fall by $3.25 million and
tax liabilities will fall by $1.75 million. Therefore, ROA would have been 12.96% ($31.75 /
$245) and ROE would have been 16.56% ($31.75 / $191.75).