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3. Profitability ratios, trading on the equity

Digital Relay has both preferred and common stock outstanding. The company reported the following

information for 20X7:

Net sales $1,750,000

Interest expense 120,000

Income tax expense 80,000

Preferred dividends 25,000

Net income 130,000

Average assets 1,200,000

Average common stockholders’ equity 500,000

Instructions

a. Compute the gross profit margin ratio, the return on equity and the return on assets, rounding

calculations to two decimal places.

b. Does the firm have positive or negative financial leverage? Briefly explain.

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