(TCO D) These are selected ratios for Widget Corporation and Tools Inc. Use this information answer the following questions.
WidgetCorp. Tools, Inc. Total asset turnover 2.5 2.0 Inventory turnover 4.6 4.0 Accounts receivable turnover 12.0 12.0 Fixed assets turnover 1.8 2.0 Net profit margin 4.5% 2.9% Assets/equity 2.10 3.3 EBIT/revenues 9.9% 8.6% Gross margin 21.1% 19.8% Income tax rate 35% 35%
Calculate Return on Equity and identify the company with the higher ROE.
We know from equity valuation models that, all other things equal, the company with the higher ROE will have a higher sustainable growth rate and thus have a higher intrinsic value.
Why are all other things not likely to be equal when comparing the ROE of these two companies?
Hint: look at components of ROE. Which company has better operating performance (ignoring capital structure)?