Comparing Financial Ratios of Two Firms
Using Differing Accounting Methods
Two firms provided the following information at the end of 1999 (dollars in millions):
|
Adam Co. |
Zachary Co. |
|
|
Total assets |
$ 105 |
$ 210 |
|
Total liabilities |
$ 70 |
$ 120 |
|
Shareholders’ equity |
$ 35 |
$ 90 |
|
Net income during 1999 |
$ 15 |
$ 25 |
|
Shares outstanding during 1999 |
1 million |
1.2 million |
|
Market price per share |
$ 125.00 |
$ 150.00 |
Required
a. Based on the information above, determine the following items for each firm:
• Earnings per share
• Price to earnings ratio
• Financial leverage ratio
b. Adam used LIFO inventory costing and accelerated depreciation of plant and equipment costs, while Zachary used FIFO costing and straight line depreciation. If Adam had been using the same inventory costing and depreciation methods as Zachary, then Adam’s net income during 1998 would have been higher by $20 million, and the carrying value of Adam’s total assets would have been higher by $85 million. Based on this information, recomputed the three ratios above as if Adam and Zachary used the same accounting methods for inventory and depreciation.
c. Describe your overall conclusions regarding the two firms.