DECISION MAKING ACROSS THE ORGANIZATION
During a recent period, the fast-food drain Wendy’s International purchased many treasury shares. This caused the number of shares outstanding to fall from 124 million to 105 million. The following information was drawn from the company’s financial statements (in millions).
Instructions
Use the information provided to answer the following questions.
(a) Compute earnings per share, return on common stockholders’ equity and return on assets for both years. Discuss the change in the company’s profitability over this period.
(b) Compute the dividend payout ratio. Also compute the average cash dividend paid per share of common stock (dividends paid divided by the average number of common shares outstanding). Discuss any change in these ratios during this period and the implications for the company’s dividend policy.
(c) Compute the debt to assets ratio and limes interest earned. Discuss the change in the company’s solvency.
(d) Based on your findings in (a) and (c), discuss to what extent any change in lie return on common stockholders’ equity was tire result of increased reliance on debt.
(e) Does it appear that the purchase of
(a)
Financial Ratios: Financial ratios are the metrics used to evaluate the overall financial performance of a company during a specific period of time.
To compute: the earnings per share for year ended after and before purchase of treasury stock.
Answer to Problem 11.6EYCT
Calculate the earnings per share for W International.
For year ended after purchase of treasury stock
For year ended before purchase of treasury stock
Explanation of Solution
Earnings per share (EPS) refers to the share of earnings earned by the shareholder on each owned. The formula to calculate the earnings per share is as follows:
Therefore, the earnings per share for year ended after purchase of treasury stock is $1.76 per share and for year ended before purchase of treasury stock is $1.03 per share.
To Compute: the return on common stockholders’ equity for year ended after and before purchase of treasury stock.
Answer to Problem 11.6EYCT
Compute the return on common stockholders’ equity for W International:
For year ended after purchase of treasury stock
For year ended before purchase of treasury stock
Explanation of Solution
Return on common stockholders’ equity ratio: It is a profitability ratio that measures the profit generating ability of the company from the invested money of the shareholders. The formula to calculate the return on common stockholders’ equity is as follows:
Therefore, the Return on Common Stockholders’ equity for year ended after purchase of treasury stock is 18% and, for year ended before purchase of treasury stock is 11%.
To Compute: the return on assets ratio for year ended after and before purchase of treasury stock.
Answer to Problem 11.6EYCT
Compute the return on assets ratio:
For year ended after purchase of treasury stock.
For year ended before purchase of treasury stock.
Explanation of Solution
Return on assets is used to measure the overall earning ability of the company. Thus, it shows the relationship between the net income and the average total assets.
The formula to calculate the return on assets ratio is as follows:
Therefore, the Return on assets for year ended after purchase of treasury stock is 9.6% and, for year ended before purchase of treasury stock is 6.5%.
To discuss: the change in the company’s profitability over this period.
Explanation of Solution
The change in the company’s profitability over this period is discussed below:
- The purchase of treasury stock increased the earnings per share from $1.03 per share to $1.76 per share thereby reducing the number of outstanding shares in the for the year ended after the purchase of treasury stock.
- The return on common stockholders’ equity increased from 11% to 18% after the purchase of treasury stock due to increased return on assets from 6.5% to 9.6%. This implies that the company is able to earn more on the money invested on assets than interest paying on its borrowings.
- Thus, the above explanations imply that the purchase of treasury stock has increased the profitability of W International.
(b)
To Compute: the payout ratio for year ended after and before purchase of treasury stock.
Answer to Problem 11.6EYCT
Compute the payout ratio for W International:
For year ended after purchase of treasury stock
For year ended after purchase of treasury stock
Explanation of Solution
Payout Ratio: It refers to a measure that evaluates the amount of dividends paid to the shareholders out of the net income earned by a corporation. It is generally expressed as a percentage. The formula to calculate the payout ratio is as follows:
Therefore, the Payout ratio for year ended after purchase of treasury stock is 13.8% and, for year ended before purchase of treasury stock is 25.1%.
To Compute: the average cash dividend paid per share for year ended after and before purchase of treasury stock.
Answer to Problem 11.6EYCT
Compute the average cash dividend paid per share for W International:
For year ended after purchase of treasury stock
For year ended after purchase of treasury stock
Explanation of Solution
Average cash dividend paid per share: It refers to a measure that evaluates the amount of cash dividend paid on each share owned by the common shareholders out of the total cash dividends paid by a corporation. The formula to calculate the average cash dividend paid per share as follows:
Therefore, the average cash dividend paid per share for year ended after purchase of treasury stock is $0.24 per share and, for year ended before purchase of treasury stock is $0.26 per share.
To discuss: the change in these ratios during this period and the implications for the company’s dividend policy.
Explanation of Solution
After the purchase of treasury stock, the company has paid lesser dividends to its common stockholders as compared to before the purchase of treasury stock. Thus, it implies that the company is intentionally retained its earnings for investing in operations.
(c)
To Compute: the debt to assets ratio for year ended after and before purchase of treasury stock.
Answer to Problem 11.6EYCT
Compute the debt to assets ratio for W International:
For year ended after purchase of treasury stock.
For year ended before purchase of treasury stock.
Explanation of Solution
Debt to assets ratio: It is the ratio that measures the ability of a company to meet its long-term obligations out of its total assets available. It shows the relationship of total liabilities and total assets.
The formula to calculate the debt to assets ratio is as follows:
Therefore, the Debt to assets ratio for year ended after purchase of treasury stock is 50.4% and, for year ended before purchase of treasury stock is 41.9%.
To Compute: the times interest earned ratio for year ended after and before purchase of treasury stock.
Answer to Problem 11.6EYCT
Calculate the times interest earned ratio for W International:
For year ended after purchase of treasury stock.
For year ended after purchase of treasury stock.
Explanation of Solution
Times interest earned ratio: This ratio that measures a company’s ability to meet its interest payments with its available earnings.
The formula to calculate the times interest earned ratio is as follows:
Therefore, the Times interest earned ratio for year ended after purchase of treasury stock is 11.2 times and, for year ended before purchase of treasury stock is 11.5times.
To discuss: the change in company’s solvency.
Explanation of Solution
The change in company’s solvency is discussed below:
- Although the purchase of treasury stock has increased the profitability of the company but reduced its solvency.
- The company has increased the debts to assets ratio from 41.9% to 50.4% that decreased the solvency rate.
- The times interest earned ratio also slightly decreased from 11.5 times to 11.2 times due to the increase in interest expenses.
- Thus, this decrease in solvency might not much worry the investors.
(d)
To discuss: to what extent the increased reliance on debts changes in the return on common stockholders’ equity.
Explanation of Solution
As from the above calculated ratios, it is seen that there is an increase in both return on assets and return on common stockholders’ equity. Thus, it can be implied that the increased reliance and debt financing as well as the increased return on assets lead to the increase in the return on common stockholders’ equity.
(e)
To explain: whether the purchase of treasury stock and the reliance on debt financing was a wise strategic move.
Explanation of Solution
From the above calculated ratios, it is found that all the calculated ratios showed an improvement after the purchase of treasury stock. Thus, it indicates that the company has effectively used its available resources to increase its profitability significantly. However, there is seen a slight decrease in solvency rate and hence, it should not be a matter of concern for the company. It can smoothly handle its debt payments.
Therefore, it can be concluded that the purchase of treasury stock and the reliance on debt financing was a wise strategic move for W International.
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Chapter 11 Solutions
Financial Accounting: Tools for Business Decision Making, 8th Edition
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