Question

• Coca-Cola’s return on assets was 19.4 percent, and return on common shareholders’ equity was 41.7 percent. Briefly explain why these two percentages are different.

• Coca-Cola had earnings per share of $5.12, and PepsiCo had earnings per share of $3.97. Is it accurate to conclude PepsiCo was more profitable? Explain your reasoning.
• Name a ratio used to evaluate short-term liquidity. Explain what the statement “evaluate short-term liquidity” means.
• Explain the difference between the current ratio and the quick ratio.
• Coca-Cola had an inventory turnover ratio of 5.07 times (every 71.99 days), and PepsiCo had an inventory turnover ratio of 8.87 times (every 41.15 days). Which company had the best inventory turnover? Explain your reasoning.
• Name a ratio used to evaluate long-term solvency. Explain what the term “long-term solvency” means.

Answer 1

(A)

The formula for return on asset is net income / average total assets.

The formula for return on equity is net income/shareholder equity.

We are given return on asset = 19.4 and return on equity 41.7

As averge total asset is not equal to shareholder equity the values are not same. Share holder Equity doesnot include long term liabilties and short term liabilities.  

Whereas total asset include bth non current and current asset.

In simpler terms we know that accounting equation is Capital + Liability = Asset

Here as liability part is not included in return on equity there is a difference in the values of return on equity and retrn on Asset.

(B)

Earning per share of Pepsico = $3.97

Earning per share of Coca Cola = $5.12

Earning per share is the dividend per share received by the shareholder. Its value is net profit/total outstanding shares.

5.12>3.97

As Coca Cola's earning per share is more than Pepsico hence it can be said that Coca Cola is more profitable.

The statement Pepiso is more profitable is not true and hence not accurate.

(C)

Quick Ratio is used to measure the short term liquidity of a business. It is also called acid test ratio.

Quick ratio is quick assets/current liabilities

Where quick assets are Current assets - Inventory - Prepaid Expenses

The quick ratio measures the company's ability to meets its short term debts with the most liquid assets. Hence prepaid expenses and inventory are not included and hence the name quick assets which can be converted to cash quickly.

Evaluating short term liquiduty means measuring the company's ability to meets its short term obligations. If the quick ratio is more than one that means the short term liabilities are fully covered and the company can pay the short term liability with the quick assets it has.

(D)

Current ratio is current asset/ current liability

Quick ratio is Quick asset/ current liability.

Current asset include prepaid expenses and inventory whereas quick asset doesnot include inventory and prepaid expenses. The ideal current ratio is 2:1 whereas ideal quick ratio is 1:1.

(E)

The formula for Inventory turnover are:

Cost of goods sold/ average inventory

or

Sales / inventory

A higher Inventory turnover indicates a better demand and better sale. Meaning tit indicates that the inventory is sold quickly and has demand. Whereas a low inventory turnover indicates a low level of demand weak sales.

Coca Cola's inventory turnover = 5.07

Pepsico's Inventory turnover = 8.87

As Pepsico's inventory turnover is higher it indicates Pepsico has better inventory turnover as its demand is higher and sales is higher.

(F)

Ratio to measure long term solvency is long term Debt to equity ratio

Debt to equity ratio is long ter debt/common equity.

The greater the company's leverage the higher is the ratio. Also a higher risk is indicated by higher ratio as company must meet both its principal and interest payments.

Long term solvency means a company's ability to meets its long term debts and obligations. It means assessing whether the company will be able to cover its long term debt or not.

A THUMBS UP WOULD BE APPRECIATED IF YOU ARE SATISFIED WITH THE EXPLANATION  

GOOD LUCK!!!