Question 7.15: A Comparison of Two Companies (2) Referring to the data for ......
A Comparison of Two Companies (2)
Referring to the data for Anson Industries and Clarence Corporation in Example 14, which of the following choices best describes reasonable conclusions an analyst might make about the companies’ ROE?
A . Anson’s inventory turnover of 76.69 indicates it is more profitable than Clarence.
B . The main driver of Clarence’s superior ROE in FY5 is its more efficient use of assets.
C . The main drivers of Clarence’s superior ROE in FY5 are its greater use of debt financing and higher net profit margin.
C is correct. The main driver of Clarence’s superior ROE (9.28 percent compared with only 5.92 percent for Anson) in FY5 is its greater use of debt financing (leverage of 2.00 compared with Anson’s leverage of 1.60) and higher net profit margin (4.38 percent compared with only 3.33 percent for Anson). A is incorrect because inventory turnover is not a direct indicator of profitability. An increase in inventory turnover may indicate more efficient use of inventory which in turn could affect profitability; however, an increase in inventory turnover would also be observed if a company was selling more goods even if it was not selling those goods at a profit. B is incorrect because Clarence has less efficient use of assets than Anson, indicated by turnover of 1.06 for Clarence compared with Anson’s turnover of 1.11.