Assessing the Effects of Operating Leverage Information is provided below from the financial statements of two companies for 2004.
|
2004 |
Jekle |
Hyde |
|
Total assets |
$30,000 |
$80,000 |
|
Total debt |
10,000 |
50,000 |
|
Total equity |
20,000 |
30,000 |
|
Sales |
28,000 |
75,000 |
|
Operating expense |
20,000 |
60,000 |
|
Operating income |
8,000 |
15,000 |
|
Interest expense |
800 |
5,000 |
|
Pretax income |
7,200 |
10,000 |
|
Income taxes (30%) |
2,160 |
3,000 |
|
Net income |
5,040 |
7,000 |
Jekle’s operating expenses include fixed costs of $5,000. Hyde’s operating expenses include fixed costs of $50,000. All other operating expenses vary in proportion to sales for both companies. Assume that during 2005 sales for both companies increased by 20% from the amount reported, to $33,600 for Jekle and to $90,000 for Hyde.
Required
A. Compute the net income Jekle and Hyde would report for 2005 if sales increased by 20%.
B. Compute return on assets for Jekle and Hyde in 2004 and 2005, assuming the increase in sales and no change in total assets.
C. Explain why the increase in sales would affect Jekle and Hyde differently and explain which company is riskier.