Question

a. Calculate the debt ratio and the return on assets using the year-end information for each of the following six separate companies (\( in thousands).

	A	B	C	D	E
1	Case	Assets	Liabilities	Average Assets	Net Income
2	Company 1	\)90,500	\(11,765	\)100,000	$20,000
3	Company 2	64,000	46,720	40,000	3,800
4	Company 3	32,500	26,650	50,000	650
5	Company 4	147,000	55,860	200,000	21,000
6	Company 5	92,000	31,280	40,000	7,520
7	Company 6	104,500	52,250	80,000	12,000

b. Of the six companies, which business relies most heavily on creditor financing?

c. Of the six companies, which business relies most heavily on equity financing?

d. Which two companies indicate the greatest risk (based on the debt ratio)?

e. Which two companies earn the highest return on assets?

f. Which one company would investors likely prefer based on the risk-return relation?

Short answer

a. The debt ratio and the ROA has been computed based on the formula:

Debt-ratio = Total Liabilities / Total Assets

ROA = Net Income / Average assets X 100

b. Company 3

c. Company 1

d. Companies 2 and 3

e. Companies 1 and 5

f. Company1

Step-by-step solution

Step-by-Step-SolutionStep 1: Part a

A	B	C	D	E	F	G
Case	Assets	Liabilities	Average Assets	Net Income	Debt Ratio (C/B)	Return on Asset (E/D)X100
Company 1	$90,500	$11,765	$100,000	$20,000	0.13	20%
Company 2	64,000	46,720	40,000	3,800	0.73	9.5%
Company 3	32,500	26,650	50,000	650	0.82	1.3%
Company 4	147,000	55,860	200,000	21,000	0.38	10.5%
Company 5	92,000	31,280	40,000	7,520	0.34	18.8%
Company 6	104,500	52,250	80,000	12,000	0.5	15%

Part b

Company 3 has an 82% of debt ratio. So, the company which rely the most on creditor financing is company 3.

Part c

Company 1 has the least percent of debt ratio (i.e., 13%). So, company 1 rely the most on equity financing.

Part d

Company 2 and company 3 have the highest debt ratio among all the companies. So, these two companies indicate the greatest risk in terms of debt ratio.

Part e

Company 1 and company 5 have the highest return on assets, which are 20% and 18.8% respectively.

Part f

Based on the risk-return relation, company 1 has the highest return (20%) and the least risk (0.13). So, company 1 would be the most preferred choice for investment purposes.