Question

Presented below are condensed financial statements adapted from those of two actual companies competing as the primary players in a specialty area of the food manufacturing and distribution industry. ($ in millions, except per share amounts.)

Balance Sheets
	Metropolitan				Republic
Assets
Cash	$	282.3			$	43.1
Accounts receivable (net)		513.7				416.0
Short-term investments		—				8.3
Inventories		562.4				719.2
Prepaid expenses and other current assets		216.6				576.7
Current assets	$	1,575.0			$	1,763.3
Property, plant, and equipment (net)		2,702.2				2,656.5
Intangibles and other assets		297.3				597.9
Total assets	$	4,574.5			$	5,017.7
Liabilities and Shareholders’ Equity
Accounts payable	$	572.9			$	781.2
Short-term notes		312.1				644.4
Accruals and other current liabilities		685.2				620.5
Current liabilities	$	1,570.2			$	2,046.1
Long-term debt		648.6				648.3
Deferred tax liability		474.6				703.7
Other long-term liabilities		215.0				193.1
Total liabilities	$	2,908.4			$	3,591.2
Common stock (par and additional paid-in capital)		229.9				440.0
Retained earnings		2,567.9				1,695.9
Less: Treasury stock		(1,131.7	)			(709.4	)
Total liabilities and shareholders’ equity	$	4,574.5			$	5,017.7
Income Statements
Net sales	$	5,794.0			$	7,856.2
Cost of goods sold		(2,818.0	)			(4,385.7	)
Gross profit	$	2,976.0			$	3,470.5
Operating expenses		(1,649.7	)			(2,933.2	)
Interest expense		(83.8	)			(43.6	)
Income before taxes	$	1,242.5			$	493.7
Tax expense		(295.7	)			(68.1	)
Net income	$	946.8			$	425.6
Net income per share	$	1.6			$	7.7

Evaluate and compare the two companies by responding to the following questions.
Note: Because comparative statements are not provided you should use year-end balances in place of average balances as appropriate.

	Metropolitan		Republic
Return on Assets		%		%
Profit Margin		%		%
Asset Turnover		times		times
Return on Shareholders' Equity		%		%
Equity Multiplier
Acid-Test Ratio
Current Ratio
Receivables Turnover		times		times
Inventory Turnover		times		times
Times Interest Earned		times		times

Which of the two firms had greater earnings relative to resources available?

Have the two companies achieved their respective rates of return on assets with similar combinations of profit margin and turnover?

From the perspective of a common shareholder, which of the two firms provided a greater rate of return?

Which company has made the most effective use of financial leverage?

Answer 1

# year-end balances in place of average balances are used in the formula -

	Metropolitan	Republic
Return on Assets = Net Income / average total assets	20.7 %	8.5 %
Profit Margin = Net Profit / sales	16.34 %	5.41 %
Asset Turnover = net sales / average total assets	1.27 times	1.57 times
Return on Shareholders' Equity = net income / equity	56.82 %	29.83 %
Equity Multiplier = total assets / stockholder's equity.	2.745	3.517
Acid-Test Ratio = (Current assets - Inventories and prepaid expenses) /  current liabilities	0.506	0.228
Current Ratio = Current assets /  current liabilities	1.003	0.8617
Receivables Turnover = net value of credit sales/  average accounts receivable	11.28 times	18.59 times
Inventory Turnover = sales / Inventory	10.3 times	10.92 times
Times Interest Earned = EBIT (Earnings before interest and taxes) / Total interest	15.826 times	12.323 times

1. Republic firm of the two firms had greater earnings relative to resources available,because of its higher EPS .
2. the two companies achieved their respective rates of return on assets with similar combinations of profit margin and turnover , however , Metropolitan firm has higher return on assets of 20.7% than Republic firm's return on assets of 8.5%.
3. From the perspective of a common shareholder, Metropolitan firm of the two firms provided a greater rate of return on equity of 56.82% compared to Republic firm's rate of return on equity of 29.83%.
4. Metropolitan company has made the most effective use of financial leverage. A figure of 0.5 or less is ideal. In other words, no more than half of the company's assets should be financed by debt.A high debt/equity ratio generally indicates that a company has been aggressive in financing its growth with debt. This can result in volatile earnings as a result of the additional interest expense. If the company's interest expense grows too high, it may increase the company's chances of a default or bankruptcy.

• Financial leverage =  total debt / total equity
• Metropolitan Financial leverage = 648.6/1666.1 = 0.389
• Republic Financial leverage = 648.3 / 1426.5 = 0.4544

Also,Generally, a lower equity multiplier indicates a company has lower financial leverage. It is better to have a low equity multiplier, because that means a company needs to use less debt to finance its assets.In all possible ways, Metropolitan company has made the most effective use of financial leverage.