Financial Analysis 334 - Math Problem Example

Ratio Formula Jones Smith Liquidity Ratio Current Assets/ Current Liabilities 150/100 5 187.5/75 = 2.5 Acid-Test Ratio Current Assets- Stock/ Current Liabilities150-50/100 = 1187.5-75/75= 1.5Coverage RatioEBIT/ Interest Expense193/8 = 24.124126/21 = 6Fixed Assets TurnoverSales / Net Fixed Assets1250/350 = 3.571000/250 = 4Gross Profit MarginGross Profit / Sales500/1250 = 40%400/1000 = 40%Net Profit MarginNet Profit / Sales92.5/1250 = 7.4%52.5/1000 = 5.25%a) Given the ratios, we can clearly see that the position of Smith Company and Jones Corporation from the lens of ratio analysis.

If we look at the liquidity ratios which tell us how much current asset does a firm have to pay-off of its short-term debts. In the case of Smith Corporation, the company has around $2.5 to pay-off every $1 of debt. This shows that company has no problem in paying off its debts. The position of Jones Corporation is also good and it will have no problem in paying off its debts. Since, both firms can pay-off their debts easily given the situation let's now eliminate the illiquid current asset factor from our ratio calculation.

In this case, if subtract the stock from current assets, still both companies can pay off their debts quite easily as their Acid-Test Ratio is equal to or greater than 1. This shows that to pay every single dollar of debt the company has the backing of adequate current assets. However, if we look the firms through the lens of Interest Coverage Ratio and if our debt commands interest from the company than, we can clearly see that Jones company can cover much higher rates of interest. As a result, Jones Corporation won't default and will be able to pay all its debts and hence a short-term loan should be made to Jones Corporation given the two different scenarios.

However, one must also state that if our loan does not command any interest, then this loan should be made to Smith Corporation.b) If we look at the profitability condition of the two companies, we can clearly see that Jones Corporation is more profitable. This can shown by the companies greater net profit over sales ratios as compared to Smith Corporation Ratios. In the light of these ratios, Jones Corporation is earning around $7 on every $100 worth of sales. Similarly, Smith Corporation is earning $4 on every $100 worth of sales.

This clearly proves that Jones Corporation is more profitable despite both the firms earning relatively the same amount of fixed assets turnover. This profitability is going to translate into heavy dividends and earn a greater return on investment than if Smith Corporation's stock is bought. Hence, from the light of Ratio Analysis, one can easily conclude that investing in Jones Corporation is going to be more profitable and hence their stock should be bought.