Expert Answers

Describe three to five industry average ratios and explain how a company’s management might use the information.

The following ratios are selected

  • Current Ratio
  • Net Margin ratio
  • Debt Ratio
  • Return on Equity
  • Fixed Asset Turnover Ratio

The company management use industry average ratio to compare against it own ratios to determine how the company is performing relative to market and tries to determine its strength and weakness so that it can improve further.

What factors might limit the effectiveness of using ratio analysis?

Problem 1

You have the opportunity to invest $10,000 in one of two companies that are part of the same industry. The only information you have about the companies is presented below. Assume that high means in the top third of the industry, average means in the middle third and low is in the bottom third. Based on this information, which company would you select? Explain you selection.

Ratio                               Company A                        Company B

ROA                                                                   Average                              High

Profit Margin                                                   Low                                     High

Financial Leverage                                         Low                                     High

Current ratio                                                    High                                     Low

Price/Earnings                                                 Average                             High

Debt-to-Equity                                                Low                                     High

Problem 2

Below are current year financial statements for two companies in the same industries and direct competitors. Both companies have been in operation approximately the same length of time.

Company A Company B
Balance Sheet
Cash 31,000 16,000
Accounts receivable (net) 29,000 24,000
Inventory 87,000 29,000
Property and equipment, net 125,000 394,000
Other assets 79,000 298,000
   Total assets 351,000 761,000
Current liabilities   91,000   47,000
Long-term debt (5% interest) 62,000 58,000
Capital stock ($5 par) 145,000 505,000
Contributed capital in excess of par 18,000 103,000
Retained earnings   35,000   48,000
    Total liabilities and stockholders’ equity 351,000 761,000
Income Statement
Sales revenue (1/3 of sales on credit) 452,000 799,000
Cost of goods sold (250,000) (396,000)
Expenses (including interest and taxes) (161,000) (308,000)
     Net income      41,000      95,000
Selected data from prior year
Accounts receivable (net) 16,000 33,000
Inventory 81,000 42,000
Property and equipment, net 110,000 375,000
Long-term debt 65,000 70,000
Other data
Market price per share at end of current year $16 $13
Average income tax rate 25% 25%
Dividends declared and paid in current year 22,000 88,000

Required:

1)      Prepare a schedule reflecting a ratio analysis of each company. Compute all ratios from the module for which you have enough data.

2)      If an investor were considering an investment in one of these companies, which would you recommend based on this data? Explain your response.

Problem 3

Below are ratios for two companies which operate in the same industry.

Company A Company B
P/E 27.8 63.0
Gross profit margin 59.1 66.2
Profit Margin 8.6 13.1
Quick .8 0.5
Current 1.2 0.65
Debt-to-equity .45 0.78
Return on equity 29.0 26.9
Return on assets 16.8 28.2
Dividend yield 1.7 1.2
Dividend payout 44.0 67.0

Required:

Evaluate the companies as a potential investment based on the given ratios.

4) The multiple step income statement discloses three subtotals of profit before reporting net income. Those three intermediate profit figures are:
Gross profit, income from discontinued operations, and income from operations.
Gross profit, income from operations, and income before taxes.
Gross profit, gain or loss from an extraordinary item, and income before taxes.
Gross profit, income or loss from discontinued operations, and income from operations.

5.  Carolina Company computed the following ratios for a two year period:(refer to image) Required: Comment on the trend of each of the ratios from 2009 to 2010. State concerns or possible implications for the future of each.