If the CEO of a large, diversified, firm were filling out a fitness report on a

Question

If the CEO of a large, diversified, firm were filling out a fitness report on a division manager (i.e., “grading” the manager), which of the following situations would be likely to cause the manager to receive a better grade? In all cases, assume that other things are held constant.

a. The division’s basic earning power ratio is above the average of other firms in its industry.

b. The division’s total assets turnover ratio is below the average for other firms in its industry.

c. The division’s total debt to total capital ratio is above the average for other firms in the industry.

d. The division’s inventory turnover is 6×, whereas the average for its competitors is 8×.

e. The division’s DSO (days’ sales outstanding) is 40 days, whereas the average for its competitors is 30 days.

Explanation / Answer

The correct option is a. The division having Earning Power ratio( EBIT/Total Assets) better than the average of other firms in the industry that means that the firm is using the assets more efficicently than the other firms.

Other options are not valid as the total Asset Turnover ratio, Inventory Turnover ratio, DSO are worse than the industry average and the Debt/CApital ratio higher than industry average that means the firm is having a higher risk of leverage. So these factors cannot give a better grade to the division manager.

Only Option a is the perofrmance criterion that will give a better grade  to the division manager.

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