Please compare Starbucks’ debt ratio in 2007 to the industry average which is given below for each measure. Was Starbucks doing better compared to the industry? Financial Ratios Industry Total Asset Turnover = Sales /Total Assets 1.53 Average Collection Period (Days) = Account Receivables/Daily Sales 11.49 Operating Margin (EBIT) =EBIT/ Sales 0.14 Debt ratio= D/A 0.42 Return on Average Asset = Net Income to Common Stocks /Average Assets 0.10 Return on Average Equity= Net Income to Common Stocks /Average Equity 0.19 Interest Coverage After Tax = (Net Income + Interest) / Interest 19.42 3. ABC Corp.’s equity multiplier is 1.25. What is its debt ratio? 4. Easy Corp.’s return on assets measure is 0.20 (20%. Its return on equity measure is 0.25 (25%). What is the firm’s equity multiplier? 5. Decorative Paintings has total debt of $69,000, total equity of $445,000, and a return on equity of 10 percent. What is the return on assets? 6. If equity multiplier for a firm is 4, what is the debt ratio for that firm? 7. measures the percentage of each sales dollar remaining after all costs and expenses, including interest, taxes, and preferred stock dividends, have been deducted. A) Net profit margin B) Operating profit margin C) Gross profit margin D) Earnings available to common shareholders 8. measures the return earned on the common stockholders’ investment in the firm. A) Net profit margin B) Price/earnings ratio C) Return on equity D) Return on total assets 9. A firm with sales of $1,000,000, net profits after taxes of $30,000, total assets of $1,500,000, and common stockholders’ investment of $750,000 has a return on equity of __. A) 20 percent B) 15 percent C) 3 percent D) 4 percent 10) The DuPont formula allows a firm to break down its return into the net profit margin, which measures the firm’s profitability on sales, and its total asset turnover, which indicates how efficiently the firm has used its assets to generate sales. TRUE FALSE
The Correct Answer and Explanation is:
Let’s address each question in detail, beginning with a comparison of Starbucks’ debt ratio in 2007.
1. Starbucks’ 2007 Debt Ratio vs. Industry Average
- Starbucks 2007 Debt Ratio: 0.38
- Industry Average Debt Ratio: 0.42
Conclusion:
Starbucks had a lower debt ratio (0.38) compared to the industry average (0.42). This means Starbucks relied less on debt and more on equity to finance its assets. This is generally a positive financial indicator, suggesting Starbucks was less risky and potentially more financially stable than its peers.
2. ABC Corp.’s equity multiplier is 1.25. What is its debt ratio?
Formula:
Equity Multiplier=11−Debt Ratio\text{Equity Multiplier} = \frac{1}{1 – \text{Debt Ratio}}
Solving for Debt Ratio:
1.25=11−Debt Ratio⇒Debt Ratio=0.201.25 = \frac{1}{1 – \text{Debt Ratio}} \Rightarrow \text{Debt Ratio} = 0.20
Answer: 0.20
3. Easy Corp. ROA = 0.20; ROE = 0.25. What is the equity multiplier?
Formula:
Equity Multiplier=ROEROA=0.250.20=1.25\text{Equity Multiplier} = \frac{\text{ROE}}{\text{ROA}} = \frac{0.25}{0.20} = 1.25
Answer: 1.25
4. Decorative Paintings: Debt = $69,000; Equity = $445,000; ROE = 10%
ROA Formula:
ROA=ROE×EquityAssets\text{ROA} = \text{ROE} \times \frac{\text{Equity}}{\text{Assets}}
Assets = $69,000 + $445,000 = $514,000
ROA=0.10×445,000514,000=0.0866\text{ROA} = 0.10 \times \frac{445,000}{514,000} = 0.0866
Answer: 8.66%
5. If equity multiplier is 4, what is the debt ratio?
Using:
Equity Multiplier=11−Debt Ratio⇒4=11−x⇒x=0.75\text{Equity Multiplier} = \frac{1}{1 – \text{Debt Ratio}} \Rightarrow 4 = \frac{1}{1 – x} \Rightarrow x = 0.75
Answer: 0.75
6. ________ measures percentage of sales dollar after all expenses?
Correct Answer: A) Net profit margin
7. ________ measures return on common stockholders’ investment?
Correct Answer: C) Return on equity
8. ROE Calculation:
Sales = $1,000,000; Net Profit = $30,000; Equity = $750,000
ROE=30,000750,000=0.04⇒4%\text{ROE} = \frac{30,000}{750,000} = 0.04 \Rightarrow 4\%
Answer: D) 4 percent
9. DuPont formula explanation
Statement: TRUE
The DuPont formula breaks ROE into:
ROE=Net Profit Margin×Asset Turnover×Equity Multiplier\text{ROE} = \text{Net Profit Margin} \times \text{Asset Turnover} \times \text{Equity Multiplier}
This helps firms analyze how profitability, efficiency, and leverage drive returns.
Explanation Summary
In 2007, Starbucks had a debt ratio of 0.38, compared to the industry average of 0.42. This means Starbucks used less debt to finance its assets, indicating a more conservative financial structure. Lower debt ratios generally suggest lower financial risk, which is favorable for long-term stability, though it may also mean less aggressive growth through leverage.
The debt ratio, defined as total debt divided by total assets, is a key indicator of a firm’s financial leverage. Starbucks’ lower ratio implies better solvency and potentially stronger creditworthiness. When compared to its peers, this suggests Starbucks was better positioned to withstand economic downturns or rising interest rates.
Several additional financial ratios support performance analysis. For example, the equity multiplier, which connects return on equity (ROE) to return on assets (ROA), reflects the degree of financial leverage. A higher multiplier suggests greater use of debt. Questions 2 through 5 explore these relationships mathematically, reinforcing that leverage can amplify returns but also risk.
Conceptual questions (6–10) assess understanding of profitability and efficiency metrics. Net profit margin and return on equity (ROE) are crucial for evaluating firm performance. The DuPont formula integrates these components, allowing deeper insights into the sources of a firm’s profitability. It dissects ROE into net profit margin (profitability), total asset turnover (efficiency), and equity multiplier (leverage), giving a comprehensive view of financial performance.
In summary, Starbucks’ lower debt ratio in 2007 indicated better financial health compared to industry norms. This conservative financing approach, combined with sound profitability and efficiency, positioned Starbucks as a stable and resilient firm within its sector
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