Task 4: Financial Statement Analysis Birds Draft Co. and Dodo Bird Co., are riva
ID: 2540433 • Letter: T
Question
Task 4: Financial Statement Analysis Birds Draft Co. and Dodo Bird Co., are rivals in the manufacture of craft papers. Some financial statement values for each company follow. Use them in a ratio analysis that compares the firms' financial leverage and profitability. Item Total assets Total equity (all common) Total debt Annual interest Total sales EBIT Earnings available for common stockholders3,690,0003 Birds Draft Co. (RM) Dodo Bird Co. (RM) 10,000,000 5,000,000 5,000,000 500,000 25,000,000 6,250,000 450,000 10,000,000 9000,000 ,000,000 100,000 25,000,000 6,250,000 Required Calculate the following debt and coverage ratios for the two companies. Discuss briefly their financial risk and ability to cover the costs in relation to each other. a. i) Debt ratio i) Times interest earned ratio b. Calculate the following profitability ratios for the two companies. Discuss briefly their profitability relative to each other. i) Operating profit margin ii) Net profit margin ii) Return on total assets iv) Return on common equity In what way has the larger debt of Dodo Bird made it more profitable than Birds Draft? What are the risks that Dodo Bird's investors undertake when they choose to purchase its stock instead of Birds Draft's? c. d· "While ratio analysis can provide some useful information concerning a company's operations and financial condition, it does have limitations". Discuss briefly.Explanation / Answer
Birds drafts
Dodo Birds
debt ratio
total liabilities/total assets
1000000/10000000
10.0%
5000000/10000000
50.00%
times interest earned
ebit/interest
6250000/100000
62.5
6250000/500000
12.5
Financial risk is high in case of Dodo Birds and ability to pay the fixed cost (interest) is better for birds draft
operating profit margin
ebit/sales
6250000/25000000
25.00%
6250000/25000000
25.00%
net profit margin
earnings available to common stock holders/sales
3690000/25000000
14.76%
3450000/25000000
13.80%
return on total assets
earnings available to common stock holders/total assets
3690000/10000000
36.90%
3690000/10000000
36.90%
return on common equity
earnings available to common stock holders/total equity
3690000/9000000
41.00%
3690000/5000000
73.80%
Dodo birds is in better position as return on equity is 73.80% in comparison to 41% of Birds draft
Interest expense is considered as tax deductible expense and due to this interest expense tax shield, earnings available to common stock holders increases and increases the return on total common equity. An investor will face financial risk when investment his funds into Dodo Birds.
Limitations of ratio analysis
(1)Ratio analysis is based on historical information so it is not expected that the same results will carry forward into the future
(2) Different ratio are having different interpretations for example ideal current ratio for manufacturing company is 2:1 while for service industry it is 1:1 so interpretation of ratio is different for firms and also for industry.
Birds drafts
Dodo Birds
debt ratio
total liabilities/total assets
1000000/10000000
10.0%
5000000/10000000
50.00%
times interest earned
ebit/interest
6250000/100000
62.5
6250000/500000
12.5
Financial risk is high in case of Dodo Birds and ability to pay the fixed cost (interest) is better for birds draft
operating profit margin
ebit/sales
6250000/25000000
25.00%
6250000/25000000
25.00%
net profit margin
earnings available to common stock holders/sales
3690000/25000000
14.76%
3450000/25000000
13.80%
return on total assets
earnings available to common stock holders/total assets
3690000/10000000
36.90%
3690000/10000000
36.90%
return on common equity
earnings available to common stock holders/total equity
3690000/9000000
41.00%
3690000/5000000
73.80%
Dodo birds is in better position as return on equity is 73.80% in comparison to 41% of Birds draft
Interest expense is considered as tax deductible expense and due to this interest expense tax shield, earnings available to common stock holders increases and increases the return on total common equity. An investor will face financial risk when investment his funds into Dodo Birds.
Limitations of ratio analysis
(1)Ratio analysis is based on historical information so it is not expected that the same results will carry forward into the future
(2) Different ratio are having different interpretations for example ideal current ratio for manufacturing company is 2:1 while for service industry it is 1:1 so interpretation of ratio is different for firms and also for industry.
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