Question 7.2: Ratio Analysis An analyst is examining the profitability of ......

1: Toshiba is far larger than the other two companies based on FY2009 revenues in US$. Toshiba’s FY2009 revenues of US$69.0 billion are far higher than either Acer’s US$17.8 billion or Lenovo’s US$16.6 billion.

Acer: At the assumed average exchange rate of 32.2 TW$/US$, Acer’s FY2009 revenues are equivalent to US$17.8 billion (= TW$573.983 billion ÷ 32.2 TW$/US$).
Lenovo: Lenovo’s FY2009 revenues totaled US$16.6 billion.
Toshiba: At the assumed average exchange rate of 92.5 JP¥/US$, Toshiba’s revenues for FY2009 are equivalent to US$69.0 billion (= JP¥ 6,381.599 billion ÷ 92.5 JP¥/ US$).

Note: Comparing the size of companies reporting in diff erent currencies requires translating reported numbers into a common currency using exchange rates at some point in time. This solution converts the revenues of Acer and Toshiba to billions of US dollars using the average exchange rate of the fiscal period. It would be equally informative (and would yield the same conclusion) to convert the revenues of Acer and Lenovo to Japanese yen, or to convert the revenues of Toshiba and Lenovo to New Taiwan dollars.

2: The growth in Acer’s revenue was much higher than either of the other
two companies.

The table 1 shows two growth metrics. Calculations are illustrated using the revenue data for Acer:

The change in Acer’s revenue for FY2009 versus FY2005 is 80.4 percent calculated as (573,983 – 318,088) ÷ 318,088 or equivalently (573,983 ÷ 318,088) – 1.

The compound annual growth rate in Acer’s revenue from FY2005 to FY2009 is 15.9 percent, calculated using a financial calculator with the following inputs: Present value = – 318,088; Future value = 573,983; N = 4; Payment = 0; and then Interest = ? to solve for growth.

Calculation of the compound annual growth rate can also be expressed as follows: [(\text{Ending value} ÷ \text{Beginning value}) ^{(1/\text{number of periods})} ] – 1 = [(573,983 ÷ 318,088)^{(1/4)} – 1 = 0.159 or 15.9 percent.

3: Profitability can be assessed by comparing the amount of gross profit to revenue and the amount of net income to revenue. The following table (table 2) presents these two profitability ratios— gross profit margin (gross profit divided by revenue) and net profit margin (net income divided by revenue)—for each year.

The net profit margins indicate that Acer has been the most profitable of the three companies. The company’s net profit margin was somewhat lower in the most recent two years (only 2.1 percent and 2.0 percent in FY2008 and FY2009, respectively, compared to 2.7 percent, 2.9 percent, and 2.8 percent in FYs 2005, 2006, and 2007, respectively), but has nonetheless remained positive and has remained higher than the competing companies.

Acer’s gross profit margin has remained consistently above 10 percent in all 5 fiscal years. In contrast, Lenovo’s gross profit margin has declined markedly over the 5-year period, but remains higher than Acer’s, which is consistent with the company’s strategic objective to achieve higher selling prices by stressing the high engineering quality of its personal computers. However, Lenovo’s net profit margin has typically been lower than Acer’s. Further analysis is needed to determine the cause of Lenovo’s gross profitability decline over the period FY2005 to 2009 (lower selling prices and/or higher costs), to assess whether this decline is likely to persist in future years, and to determine the reason Lenovo’s net profit margins are generally lower than Acer’s despite Lenovo’s higher gross profit margins.

Because Toshiba is a conglomerate, profit ratios based on data for the entire company give limited information about the company’s personal computer business. Ratios based on segment data would likely be more useful than profit ratios for the entire company. Based on the aggregate information, Toshiba’s gross profit margins are higher than either Acer’s or Lenovo’s gross profit margins, whereas Toshiba’s net profit margins are generally lower than the net profit margins of either of the other two companies.