Question

11. You are given the information of firm A and B for their performance evaluation. Firm                              A                B                Sales                            60               55               EAT                               20               18               Total Assets                   75               72               Stockholder’s Equity       40               40               Suppose the industry average of net profit margin ratio, total asset turnover and equity multiplier is around 30%, 0.78 times and 1.9 respectively. Which firm appears to have problems?        Firm A has problems.        Firm B has problems.        None of them presents problems.        Both of them presents problems.

Question 12. Continued from Question above, which of the following is true?        Firm A shall restructure its capital structure to achieve a higher financial leverage since it appears to be lower than the industry average.        Firm A shall improve its total asset turnover ratio since it is higher than the industry average and thus indicates an inefficient utilization of assets.        Firm B shall improve its total asset turnover ratio since it is lower than the industry average and thus indicates an inefficient utilization of assets.

Answer 1

Net profit margin ratio of firm A = EAT/Sales

= 20/60

= 33.33%

Total assets turnover of firm A = Sales/Total assets

= 60/75

= 0.80 times

11.

Equity multiplier of firm A = Total assets/ Stockholders' equity

= 75/40

= 1.875

Net profit margin ratio of firm B = EAT/Sales

= 18/55

= 32.73%

Total assets turnover of firm B = Sales/Total assets

= 55/72

= 0.76 times

Equity multiplier of firm B = Total assets/ Stockholders' equity

= 72/40

= 1.8

Comparison of firm A , firm B and the industry

	Firm A	Firm B	Industry
Net profit margin ratio	33.33%	32.73%	30%
Total assets turnover	0.80 times	0.76 times	0.78 times
Equity multiplier	1.875	1.8	1.9

Net profit margin ratio, total assets turnover ratio and equity multiplier of firm A and firm B are more or less, close to the industry averages. Hence none of the firms presents problems.

Hence, correct option is (c)

12.

Firm B shall improve its total assets turnover ratio since it is lower than the industry average and thus indicates an inefficient utilisation of assets.

The above statement is true. Firm B's Total assets turover is 0.76 times, which is less than industry avergae of 0.78 times. Hence, there is a potential to improve total assets turnover ratio to make it at par with industry average.

Remaining two statements are false. Firm A's total assets turonver is above industry average, hence firm A is utilizing its assets more efficiently as compared to the industry.

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