Question

5. Profitability ratios Profitability ratios help in the analysis of the combined impact of liquidity ratios, asset management ratios, and debt management ratios on the operating performance of a firm. Your boss has asked you to calculate the profitability ratios of Petroxy Oil Co. and make comments on its second-year performance as compared to its first-year performance. The following shows Petroxy Oil Co.'s income statement for the last two years. The company had assets of $11,750 million in the first year and $18,796 million in the second year. Common equity was equal to $6,250 million in the first year, and the company distributed 100% of its earnings out as dividends during the first and the second years. In addition, the firm did not issue new stock during either year Petroxy Oil Co. Income Statement For the Year Ending on December 31 (Millions of dollars) Year 2 Year 1 6,350 5,000 1,495 200 1,695 4,422 3,305 347 3,980 2,958 1,183 1,775 Net Sales 1,610 318 1,928 Operating costs except depreciation and amortization Depreciation and amortization Total Operating Costs Operating Income (or EBIT) Less: Interest Earnings before taxes (EBT) Less: Taxes (40%) Net Income 442 1,592 2,388'

Answer 1

Current ratio = current assets / current liabilities

Quick Ratio = (Cash and Equivalents + Marketable Securities + Accounts Receivable) / Current Liabilities

Company	Current ratio	Quick ratio
Free Spirit Industries	=4950/3712=1.3335	=(2029+0+743)/3712=0.7467
Jing Foodstuffs	=7700/4640=1.6595	=(3157+0+1155)/4640=0.9293

The more the ratios the better the ability to service short term obligations

Therefore 1st statement is true; Jing Food stuffs has better ability to service short term obligations than Free Spirit Industries

2nd statement is true: Current ratio of 1 means current assets = current liabilities

3rs statement is true: If quick ratio is less than 1 and current ratio is more than 1 and the difference is huge, it means that cash and marketable securities can be used less to serve current liabilities whereas inventory is a major component of serving current liability

4th statement:False: Jing foodstuffs has more current ratio than Free spirits; therefore it has more not less liquidity than Free spirits;

5th statement: True as more current ratio means more liquidity and short term obligation servicing by definition