Question

1. Comparing Operating Characteristics Across Industries: Followings are selected income statement and balance sheet data companies in different industries.

$millions	Sales	Cost of Goods Sold	Gross Profit	Net Income	Total Assets	Total Liabilit.	Stockholders’ Equity
Target Corp	73785	51997	21788	3363	40262	27305	12957
Nike Inc	32376	17405	14971	3760	21396	9138	12258
Harley-Davidson	5995	3620	2375	752	9991	8151	1840
Cisco System	49247	18287	30960	10739	58067	58067	63585

a)   Compute the following ratios for each company:

	Gross Profit/ Sales	Net Income/ Sales	Net Income/ Stockholders’ Equity	Liabilities/ Stockholders’ Equity
Target Corp
Nike Inc
Harley-Davidson
Cisco System

b)   Comment on any differences among the companies’ gross profit-to-sale ratios and net income as a percentage of sales. Do differences in the companies’ business models explain the differences observed?

c)   Which company reports the highest ratio of net income to equity? Suggest one or more reasons for this result.

d)   Which company has financed itself with the highest percentage of liabilities to equity? Suggest one or more reasons for this result on such debt levels.

Answer 1

a)

	Gross Profit/ Sales	Net Income/ Sales	Net Income/ Stockholders’ Equity	Liabilities/ Stockholders’ Equity
Target Corp	29.53%	4.56%	25.96%	2.11
Nike Inc	46.24%	11.61%	30.67%	0.75
Harley-Davidson	39.62%	12.54%	40.87%	4.43
Cisco System	62.87%	21.81%	16.89%	0.91

b) We can observe differences between Gross Profit/Sales and Net Income/Sales. Gross profit/ Sales is gross profit margin, it is the margin considering cost of goods sold. Net income/Sales is net profit margin considering the COGS, Finance cost, operational expenses, this is more stringent measure of profitability. Difference being large in the case of Target Corp and Nike Inc, as these are mostly run through retail chains, their operating expenses will be high. Cisco system being a software company will have low COGS and gross profit margin will be high. Harley Davidson is providing better net profit margin in comparison to Nike Inc even when gross profit margin is less.

c)Harley Davidson is reporting highest Net Income/ Stockholders’ Equity, ROE. Every company requires funds to grow. The cash for investment can come from retained earnings, issuing new equity, or borrowing. In the first two cases, the ROE will capture this use of capital to grow. In the latter case, the debt used for growth will improve returns, but won’t affect the total equity. That will make the ROE look better than if no debt was used. Harley-Davidson makes extensive use of debt to improve its returns, because it has a relatively high Liabilities/ Stockholders’ Equity of 4.43. That is the reason for impressive ROE.

d) Harley Davidson is reporting highest Liabilities/ Stockholders’ Equity, debt to equity ratio. The company is using debt to finance all major investments, this is to retain good return on equity.