This assignment will require you to perform some analysis of financial ratios and some research from other sources to further your understanding of financial ratios.

You will select an industry and two firms within the industry as described below and analyze the Return on Equity (ROE) of both firms and the market valuation ratios.

Be sure you carefully review the rubric and the information in the Data, ROE, Assignment Details, and Deliverable sections.

Data

1. Data Source: Locating Company and Industry Information Research Guide (Hunt Library) (Links to an external site.)
2. Select 'Key Business Ratios' from the guide menu.
3. Follow instructions for Mergent Online to generate a report including industry and selected firms.

Your submission should include a spreadsheet as described in the rubric. This should include your selected firms as well as a summary of the industry’s ratios.

For this assignment, you will be looking at a number of ratios for a firm and comparing to industry averages.

Return on Equity (ROE)

For this assignment, you will focus on one ratio which can actually be calculated using three other ratios. That ratio is the Return on Equity (ROE).

ROE can be calculated in the following manner:

ROE = [net profit margin] x [asset turnover] ÷ [equity ratio]

ROE = [earnings to owners ÷ revenues] x [revenues ÷ assets] ÷ [common equity ÷ assets]

ROE = [earnings to owners ÷ revenues] x [revenues ÷ assets] x [assets ÷ common equity]

Look at what cancels and you are left with:

earnings ÷ equity which is ROE

ROE is comprised of:

Profit Margin (bottom line)

Turnover (asset utilization)

Equity ratio (financial cushion)

A note on equity ratio: (equity/assets):

Say a firm had $100 in assets and $37 dollars in equity;

The equity ratio would be 37/100 or 0.37.

What does that mean?

How can a firm be financed?

How much came from equity (owners)?

How much from creditors?

In this case, for every dollar of assets, owners have funded 0.37 cents and creditors 0.63 cents.

The second set of ratios you will need to consider are market value ratios. How does the firm you selected compare to industry averages, main competitor(s) etc.

Assignment Details

For this assignment, you will need to select an industry using the referenced database and download the data. Select two firms, one with a relatively high ROE and one with a relatively low ROE in the industry. Analyze each of the firms taking into consideration the components of ROE as identified above. This will require you to do some additional research regarding ROE analysis.

The information you will need is not all here or in the textbook. There are times in the workplace where you will be performing or asked to perform tasks that require some learning/teaching yourself. This assignment will require you to do that.

Hints:

• You may want to look at each of the components of ROE and compare those.
• You may want to look up DuPont Identity or DuPont Analysis in other sources to assist in your learning.
• Realize the components you need to analyze may or may not be in the spreadsheet you download from the referenced database.
  • If not, find what you need but make sure you document where you find any data used. (Yahoo finance is a good site and there are others.)

Some thoughts to keep in mind:

• Margins reflect the firm’s production function. If margins are low, what could be done to improve them?
• Total asset turnover deals with the marketing function. If turnovers are low, what might a firm wish to consider to improve its performance?
• Equity ratio is the finance province. Issues to consider are if you are being too conservative (not employing enough cheap debt)?

Deliverable

Write a brief paper about 2 to 2 ¹/₂ pages in length. Your paper should address the reasons why one firm has a high ROE, why one firm has a low ROE and what could be done to improve the lower performing firm based on ROE (if it is really performing at a lower level). Perform similar contrast and comparisons for the market value ratios.

Be sure to address issues such as marketing, asset utilization, financing and if your chosen firm appears to be under or overvalued.

• Include the downloaded industry spreadsheet for the industry you selected.
• Identify the firms you selected within the spreadsheet by changing the color of the font for that firm on each tab to red.
• Prepare a table that calculates the ROE for each firm using the three components. Make sure each column is labeled.
  • You should have columns that are labeled ROE, Net Profit Margin, Asset Turnover, and Equity Ratio.
  • Create a similar table for the market value measures.

Be sure you have addressed all criteria in the rubric and the information in the Data, ROE, Assignment Details, and Deliverable sections.