Academy Driving School reported the following amount in its financial statements
ID: 2664673 • Letter: A
Question
Academy Driving School reported the following amount in its financial statements:
2010
2009
Number of common shares
11,500.00
11,500.00
Net Income
$ 23,000.00
$ 18,000.00
Cash Dividends paid on common stock
$ 3,000.00
$ 3,000.00
Total Stockholders equity
$ 240,000.00
$ 220,000.00
Calculate 2010 EPS and ROE. Another driving school in the same city reported a higher net income ($45,000) in 2010, yet its EPS and ROE ratios were lower than those for the Academy Driving School. Explain how this apparent inconsistency could occur.
2010
2009
Number of common shares
11,500.00
11,500.00
Net Income
$ 23,000.00
$ 18,000.00
Cash Dividends paid on common stock
$ 3,000.00
$ 3,000.00
Total Stockholders equity
$ 240,000.00
$ 220,000.00
Explanation / Answer
ROE is (Net Income available to common stockholders)/(Common stockholders' equity) EPS is (Net income available to common stockholders)/(total shares of common stock outstanding) ROE = $23,000/$240,000 = .096 For further explanation, ROE is the return on the common stockholders' investment in the assets of the firm. It is a ratio that expresses what a company is able to earn with what cash they have from their stockholders. EPS = $23,000/11,500 = $2.00 So you have this other company that has a higher net income. Why then is there ROE and EPS both lower? The ROE could be lower because the other company might have a much larger amount of shareholders' equity. For example: lets say the other company's shareholders' equity is $500,000. That would make their ROE 45,000/500,000 = .9. This is of course lower. The EPS could be lower if they have more outstanding common shares. For example: lets say that the other comany's number of outstanding common shares is 30,000. That would make their EPS $45,000/30,000 = $1.50. Another potential is that the other company has preferred stocks that they have to pay dividends out on. Net income available to common stockholders is net income minus the dividends paid on preferred stocks. Preferred stocks are always paid out before common stocks. As a note the Cash dividends paid on common stock would be used in DPS(dividends per share). Do not let that one confuse you.