Selected financial data from the September 30 year-end statements of Kosanka Company are given below:

Selected financial data from the September 30 year-end statements of Kosanka Company are given below:

Total assets	$	5,500,000
Long-term debt (11% interest rate)		600,000
Preferred stock, $100 par, 8%		600,000
Total stockholders’ equity		2,800,000
Interest paid on long-term debt		66,000
Net income	$	420,000

Total assets at the beginning of the year were $5,300,000; total stockholders’ equity was $2,600,000. There has been no change in preferred stock during the year. The company’s tax rate is 35%.

Required:

1.	Compute the return on total assets. (Round your answer to 1 decimal place. Omit the "%" sign in your response.)

Return on total assets

%

2.	Compute the return on common stockholders’ equity. (Round your answer to 1 decimal place. Omit the "%" sign in your response.)

Return on common stockholders’ equity

%

3.	Is the company’s financial leverage positive or negative?
	Positive

Explanation:

1.

Return on total assets:

Return on total assets	=	Net income + [Interest expense × (1 − Tax rate)]
		Average total assets
	=	$420,000 + [$66,000 × (1 − 0.35)]
		($5,500,000 + $5,300,000) / 2

	=	$462,900	= 8.6% (rounded)
		$5,400,000

2.

Return on common stockholders’ equity:

Average stockholders’ equity      ($2,800,000 + $2,600,000) / 2	$	2,700,000
Average preferred stock ($600,000 + $600,000) / 2		600,000
Average common stockholders' equity	$	2,100,000

Preferred Dividends = 8% × $600,000 = $48,000

Return on common stockholders' equity	=	Net income − Preferred dividends
		Average common stockholders' equity

	=	$420,000 − $48,000	= 17.7% (rounded)
		$2,100,000

3.

Leverage is positive because the return on common stockholders’ equity (17.7%) is greater than the return on total assets (8.6%).