Solvent Ltd is considering expanding its business and comparing between two potential opportunities for investment in either company X or company Y.
The president of Solvent has asked the controller to prepare a report that summarises the financial aspects of the two potential investees for the last year.
The controller has presented a number of financial ratios that can assist in the identification and interpretation of trends for each investee. The following ratios have been calculated for the year ended 31st December 2012 for each company:
|
Ratio
|
Company X
|
Company Y
|
|
Current ratio
|
2
|
1.50
|
|
Acid-test ratio
|
1
|
0.80
|
|
Accounts receivable days
|
50
|
80
|
|
Inventory turnover (times)
|
8
|
5
|
|
Accounts payable days
|
90
|
60
|
|
Percent of long-term debt to total assets
|
30%
|
40%
|
|
Gearing
|
25%
|
55%
|
|
Gross profit percentage
|
40%
|
30%
|
|
Operating profit percentage
|
25%
|
15%
|
|
Return on capital employed
|
30%
|
22%
|
|
Return on equity
|
20%
|
10%
|
|
Interest cover (times)
|
10
|
6
|
|
Earnings per share
|
1
|
1.50
|
|
Operating cash flow per share
|
2.10
|
1.30
|
|
Required
|
|
|
a) Write a report to the Board of Directors of Solvent Ltd to analyse the performance of companies X and Y and to give recommendation as which of those two investment opportunities is better. Your report should include comments on as much performance areas as data allow.
b) Discuss and analyse the limitations of ratio analysis for both cross-sectional and time-series comparisons.