Ratios Tell A Story 2007 Case Solution
Return on Assets:
Return on assets also uses the total assets as a denominator, meanwhile, instead of sales revenues, it uses the net income that a company has generated suing the assets deployed in the business. Therefore, due to the fact the companies in staffing service industry do not have a high level of fixed assets, it be established that the companies in the staffing service industry will have the highest return on assets. Hence, company #4can be categorized as a company in staffing service industry. Further, the second highest return on asset ratio is of the company#2 which has been categorized in the software industry, this is because the main resource of companies in software industries, are the software engineers and developers instead of other property plant and equipment.
Financial leverage ratio calculates the investment in assets using the debt finance at times of equity financing. However, an evaluation of the 13 industries shows that banking industry heavily rely on debt financing in comparison to the equity financing because their main source if business is taking deposits from the customer and utilizing them in creating assets such as loan to commercial companies and other business individuals, which is common practice in the banking industry i.e. to rely more on debts in order to finance the assets instead of equity capital. Hence, the analysis of the financial leverage ratios of 13 companies reveals that company at #11 has the highest financial leverage of 12.11 times, therefore, it can be established that this company is in commercial banking industry. Meanwhile, the second highest financial leverage is of the company at #7, which is classified in the airline industry because the Airbuses are usually financed through debt capital.
Return on Equity:
Return on equity is calculated using the net income and the equity capital of the ordinary shareholders. However, the fact that how much equity value a company has depended on the requirement of capital expenditure for developing the infrastructure at the establishment date of a company, the higher the initial expenditure is, the higher will be the required equity investment. Therefore, industries that require low initial investment in infrastructure or the other capital expenditure will have the lower shareholders’ equity and hence the highest return on equity. The analysis of the 13 companies reveals that company at #7 has the highest return on equity ratio, meanwhile, the analysis of provided industries shows that the airline industry does not require heavy investment in building the distribution channel because the airplanes are largely financed through debt capital and do not require a high level of equity investment for the purchase of airplanes.
Therefore, company number eleven can be classified in the airline industry. Further, the second highest return one quity ratio is of company at #3 and this company can be classified in the internet retail industry because the sales are made through the internet, hence, no investment is needed to develop infrastructure or distribution channels, therefore, they require low equity finance and as a result generate higher returns on shareholders’ equity………………….
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