Question

Problem x. You have to make an investment decision, between the following two companies. Compare them and give your arguments (minimum 10) for your decision (CALCULATIONS FOR MAKING COMPANIES COMPARABLE ARE REQUIRED). The information needed is given below.

Balance Sheet
	Company A	Company B
Assets
Cash	31,000	63,000
Account receivable (net)	20,000	18,000
Inventory	64,000	70,000
Land	270,000	669,000
Building	1,200,000	1,500,000
Accumulated depreciation - Building	(20,000)	(100,000)
Furniture	750,000	900,000
Accumulated depreciation - Furniture	(75,000)	(180,000)
Total Assets	2,240,000	2,940,000
Liabilities and OE
Liabilities	1,300,000	1,000,000
Owner Equity	940,000	1,940,000
Total Liabilities and OE	2,240,000	2,940,000

Net profit for the year: Company A – 500,000

                                           Company B – 400,000

Inventories

Company A uses FIFO method, and Company B – LIFO. If A has used LIFO system, ending inventory would have been 7,000 lower.

Plant Assets

Company A uses straight-line method, with 40 years for buildings and 10 years for furniture, with estimated residual values of 400,000 for buildings and 0 for furniture. Buildings are 1 year old.

Company B uses double-declining method, with 30 years for buildings. Furniture is 1 year old and has useful life of 10 years.

Accounts receivable

Company A uses direct write-off method and projects that 2,000 of receivables are doubtful; while a Company B uses allowance method.

Answer 1

Answer :

Following factors that determine the company which is most beneficial for investment

(1). Current asset ratio shows the ability of the company to pay debt and liabilities. Current assets are more liquid assets that are esaily converted in to money

Current assets = Cash + Receivable + Inventory

Current assets of company A = 115000 and Company B = 151000

Company A should required to lower the inventory by 7000

Comapny Bs current assets are more represent ability to pay liabilities and debt

Choose compnay B to invest

(2). Deprecition on assets impacts the profit of the company. Companies are follow the policy to defer the depreciation expenses to be charged to profit and loss, show more profits. On the other hand company expense depreciation more to defer tax liability and increase working capital by adding derpeciation, because depreciation is non cash item

Company A follows straight line method of depreciation where as compnay B follow double decline method of depreciaiton.Double decline method allows derpeciation at double rate. Depreciation policy is significant aspect of financial policy. The pattern and quatom of charge of depreciation effects companys dividend and retention policy.

Double decline method is efficient than straigt line method.

Therefore company B follows accounting policies more precisely.

(3). If company already bearing more long term liabilities then making investment is risky

Comapny A has more liabilities than comapny B

Coampny B is fair to invest

(4). Debt equity ratio calculated by total liabilities divided by equity. This ratio measures the degree to which compnay is financing to its operation. Higher ratio indicates higher risk

Ratio of company A = 1300000 / 940000 = 1.38

Ratio of company B = 1000000 / 1940000 = 0.515

Comapny A has higher ratio indicates higher risk to invest

(5). Profitability of company A shows more higher risk to invest

More profit shows more return to investors

(6). Debt to total asset ratio indicates company asset financed by creditors. Calculated by liabilities divided by total assets

Comapny A = 1300000 / 2240000 = 0.58

Comapany B = 1000000 / 2940000 = 0.34

Higher ratio means percentage of assets financed by lendors. Indicate more debt

Company B = is efficient

(7). Return on asset ratio provide for how much profit is company generate from its asset

Calculated by = Profit / Total asset

A = 500000 / 22400000 = 0.22

B = 400000 / 2940000 = 0.14

Coampany A s Return on asset is more than B

(8). Return on equity measures the profitability in relation to shareholders equity

Net income / Shareholders equity

A = 500000 / 940000 = 0.53

B = 400000 / 1940000 = 0.21

Coampny A generate more profit in relation to equity

(9). Write off method allows direct express to profit and loss account and allowance method provides to uncollectible account.

Allowance method allows for in advance uncollectible

Based on above points comapny B should be choose to invest. Because company B have less risky to invest.