Question

In: Accounting

Wendy's International, Inc., and McDonald's Corporation, two leading fast-food chains, are classified in SIC code 5812—Eating...

Wendy's International, Inc., and McDonald's Corporation, two leading fast-food chains, are classified in SIC code 5812—Eating Places. Recent results for each company, along with industry averages, follow.

Wendy's

McDonald's

Industry Average

Return on assets

?7.7%

?9.9%

?6.4%

Return on common stockholders' equity

11.9%

17.7%

14.0%

Net income as a percentage of sales

?7.4%

12.7%

?2.9%

Debt-to-equity ratio

??.67

??.98

?1.04

(a)  Which company has the stronger profitability position? Why?

(b)  Which company uses more debt? Why?

(c)  How do Wendy's and McDonald's compare to the industry averages? Based on your analysis, would you consider these two companies to be industry leaders? Why or why not?

(d)  The industry data reported here represent Dun and Bradstreet's industry median. Dun and Bradstreet also reports industry norms for the upper quartile (top 25%) of companies in the industry. In the top quartile, return on assets was 15.1%, return on common stockholders' equity was 34.7%, and net income as a percentage of sales was 6.1%. Do you think it would be more useful to compare Wendy's and McDonald's to these upper-quartile industry averages rather than to the median averages? Why or why not?

(e)  Dun and Bradstreet also provides industry data based on companies' total assets. In the industry's largest reporting companies, the median return on assets was 5.1%, the median return on common stockholders' equity was 9.7%, the median net income as a percentage was sales of 3.6%, and the median debt-to-equity ratio was 0.93. The upper quartile values were 8.4%, 16.4%, 5.2%, and 0.65, respectively. Given that Wendy's and McDonald's are among the largest companies in this industry group, does this data change your answers to questions (c) and (d)? Why or why not?

Solutions

Expert Solution

Question (a)

The primary indicator is profitability of a Company is the Net Income as a percentage of sales. This is because, this parameter measures the profit on each dollar of sales made, irrespective of the capital invested. The Net income/Sales Reutrn on Assets and Return on Equity are indicator that are biased by the amount invested by the company. Hence, if we have to compare the absolute profitability of the companies Net Income/Sales is the best measure.

According to the Data given above: Mcdonald's is in a better profitability position as it earns 12.7% of its sales as net income as compared to 7.4% of Wendy's.

Question (b)

The debt equity ratio indicates the value of debt as compared to value of equity.

i.e Debt/Equity.

Note that this is only a compartive measure. For example Wendy's debt equity ratio of 0.67 indicates it uses 0.67 cents of debt for every dollar of equity. Mcdondalds uses 0.98 cents of debt for every dollar of equity. Hence Mcdonalds uses more debt to fund its capital.

However, this does not mean the absolute value of debt in Mcdonalds is more than that of Wendy's. This would change depending upon the total capital used by each firm.

Question (c)

Mcdonalds is definitely a industry leader. The primary performance indicators - Net income as a % of Sales, Return on Equity and Return on Assets is far ahead of the industry median. Debt equity only measure their capital structure and does not have any direct relation to the Company's performance.

Wendy's on the other hand is a leader if we analyse Net income aas a % of Sales and Return on Assets which are greater than the industry median. However, the return on equity is less than the industry median which indicates that the owners in this Company get less returns than the industry median. This is most likely due to their low utilisation of debt to leverage their business which results in less returns to equity shareholders as well. However, comparing majority of the stats, they would be considered industry leaders.

Question (d)

Reasons for comparing in the upper quartile

Considering that Wendy's and Mcdonalds are leading firms in the industry it would make sense to compare it with the upper quartile since larger firms tend to have exclusive synergys and economies of scale. The industry median is the middle number which may be skewed because of the existence of many small firms in the industry. The Capital base of all the company's in the data is not comparable.

However, if one wants to analyse the industry as a whole rather than understanding the performance of these 2 firms, comparing with the Median makes more sense as it gives a better picture of how far ahead these 2 firms are ahead of the competition -small and big.

Question (e)

Using the industry data based on companies total assets:

question c - The return on assets, return on equity and Net income as a % of sales is still much superior for Wendy's and Mcdonald's. Considering the data pertains to only the largest reporting companies, this is further indication that Wendy's and Mcdonalds are the industry leaders.

question d - If the data pertained to only the Company's with the largest asset based, the appropriate comparison would be against the median and not the top quartile. This is because, the skewness caused because of the existence of smaller competitors is already removed. The Capital base of all the company's in the data become comparable.


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