A financial analyst for Quality Investments, a diversified investment fund, has gathered the following information for the years 2008 and 2009 on two firms-A and B-that it is considering adding to its portfolio. Of particular concern are the operating and financial risks of each firm.
|
|
2008
|
2009
|
|
Firm A
|
Firm B
|
Firm A
|
Firm B
|
|
Sales ($ million)
|
10.7
|
13.9
|
11.6
|
14.6
|
| EBIT ($ million) |
5.7 |
7.4 |
6.2 |
8.1 |
| Assets ($ million) |
|
|
10.7 |
15.6 |
| Debt ($ million) |
|
|
5.8 |
9.3 |
| Interest ($ million) |
|
|
0.6 |
1.0 |
| Equity ($ million) |
|
|
4.9 |
6.3 |
a. Use the data provided to assess the operating leverage of each firm (using 2008 as the point of reference). Which firm has more operating leverage?
b. Use the data provided to assess each firm's ROE (Cash to equity/Equity), assuming the firm's Return on Assets is 10 percent and 20 percent in each case. Which firm has more financial leverage?
c. Use your findings in parts (a) and (b) to compare and contrast the operating and financial risks of Firms A and B. Which firm is more risky? Explain.