Question

JetCo is a manufacturer of high speed aircraft. The company generates $100 million in operating profit on $600 million of revenue and $800 million of invested capital. JetCo’s primary competitor Gulf Aviation also generates $100 million in NOPLAT. Gulf Aviation is slightly larger; the company recorded $800 million in revenue. Gulf Aviation has $600 million in invested capital.

DefenseCo announces a purchase of Gulf Aviation for $1.1 billion in cash. Consequently, Gulf Aviation’s invested capital with goodwill and acquired intangibles rises from $600 to $1.1 billion. Next year, while conducting its annual review of Gulf Aviation, senior management at DefenseCo asks you the following questions: Based on the profitability figures presented in Question 1, is Gulf Aviation creating value for DefenseCo? Which company, JetCo or Gulf Aviation, has the best financial performance in the industry?

Answer 1

To find the answer to the question whether Gulf co. is creating value for defense company or not we will answer profitability question first:

Particulars	Jet Co	Gulf Aviation
Profit (a)	$ 100 Mn	$ 100 Mn
Revenue (b)	$ 600 Mn	$ 800 Mn
Capital Invested (c)	$ 800 Mn	$ 600 Mn
ROC (Return on capital Invested) (a/c)	12.50%	16.66%
Net Profit Ratio (a/b)	16.66%	12.50%

Based on above ratio analysis, it can be seen that Jet Co. Ltd has provided Return on capital at 12.50%, while Gulf aviation has provided the same at 16.66%. It means Gulf aviation can garner more profit in less capital, on the other hand Jet Co. Ltd is more capital intensive company.

When considered from return on capital angle, Gulf aviation is a better company but when considered from industry perspective Jet Co. has produced better operational results than Gulf aviation and hence Jet co. would be a better co.

Hence, questions are answered as follows:
1. Gulf aviation surely provides better Return on Capital Invested, hence it is creating value for defense company Ltd. Considering the fact that Defense co has paid for goodwill and intangibles Return on Capital ratio will go down but still Gulf aviation is creating value for Defense co.

2. Considering from Industry perspective, Net Profit ratio of Jet Co. is better which shows that its operational efficiencies are more than Gulf aviation. Hence, from Industry criterion Jet Co. is better co.