The relationship between financial leverage and profitability
The relationship between financial leverage and profitability Blue Nile Paper, Inc., and Timberland Forest, Inc., are rivals in the manufacture of craft papers. Some financial statement values are for each company follow.Use them in a ratio analysis that compares the firms’ financial leverage and profitability. Item Blue Nile Paper Inc. Timberland Forest Inc. Total assets $10,000,000 $10,000,000 Total equity (all common) 9,000,000 5,000,000 Total debt 1,000,000 5,000,000 Annual interest 100,000 500,ooo Total sales $25,000,000 $25,000,000 EBIT 6,250,000 6,250,000 Earnings available for common stockholders 3,690,000 3,450,000 A. Calculate the following debt and coverage ratios for the two companies. Discuss their financial risk and ability to cover the costs in relation to each other. 1. Debt Ratio 2. Times interest earned ratio B. Calculate the following profitability ratios for the two companies. Discuss their profitability relative to each other. 1. Operating profit Margin 2. Net profit margin 3. Return on total assests 4. Return on common equity C. In what way has the larger debt of Timberland Forest made it more profitable than Blue Nile Paper? What are the risks that Timberland’s investors undertake when they choose to purchase its stock instead of blue Nile’s?
