Question

In: Finance

Please use the financial ratio data below to answer the following questions. Assume the two firms...

Please use the financial ratio data below to answer the following questions. Assume the two firms are in the same industry:

FIRM A FIRM B

Asset Turnover	0.62	Asset Turnover	0.63
Price-earnings Ratio	20	Price-earnings Ratio	15
Current Ratio	1	Current Ratio	0.9
Profit Margin (%)	8.2	Profit Margin (%)	7.9
Financial Leverage	2.5	Financial Leverage	5.5
Times Interest Earned	5	Times Interest Earned	2
Return on Equity (%)	12.7	Return on Equity (%)	27.4

5a. Which firm would you prefer to give a short-term loan? Name the ratio/s you looked at to make your choice.

5b. Which firm would you prefer to give a long-term loan? Name the ratio/s you looked at to make your choice.

5c. Which firm is the most profitable? Name the ratio/s you looked at to make your choice.

5d. According to the DuPont Identity, which ratio is causing Firm B’s ROE to be higher than Firm A’s ROE?

Expert Solution

5a. Which firm would you prefer to give a short-term loan? Name the ratio/s you looked at to make your choice.

we have to look into current ratio which gives the company's ability to payoff the short term liabilities. The higher the current ratio the better for the bank to issue short term loan Thus the Bank should select Firm A to give short term loan as its Current ratio is higher than Firm B

5b. Which firm would you prefer to give a long-term loan? Name the ratio/s you looked at to make your choice.

we have to look into Financial Leverage which gives the amount of assets financed by equity & times interest earned which gives the company's ability to payoff the debt obligations based on the income. The lower the financial leverage the better and the higher the time interest earned the better for the bank to issue long term loan Thus the Bank should select Firm A to give long term loan as its financial leverage is lower and times interest earned ratio is higher than Firm B

5c. Which firm is the most profitable? Name the ratio/s you looked at to make your choice.

we have to look at Profit margin ratio to analyze the company's performance in the profitability department the higher the margin the better. Firm A is performing better than Firm B as its profit margin is higher

5d. According to the DuPont Identity, which ratio is causing Firm B’s ROE to be higher than Firm A’s ROE?

Dupont identity = Profit Margin * Asset Turnover * Equity Multiplier

Dupont identity Firm A = 8.20% * 0.62 * 2.50

Dupont identity Firm B = 7.90% * 0.63 * 5.50

The big contributor of higher ROE to firm B is the Financial Leverage

jeff jeffy answered 2 years ago

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