Question

Presented below is financial analysis data for two companies that are identical in every respect except that company X uses FIFO method to value its inventory, and company Z uses the LIFO method to evaluate its inventory.

Using this data, calculate the following ratios;

1. Return on Sales
2. Inventory turnover
3. Inventory on hand period
4. Current Ratio

Which of the two companies is a better investment opportunity and why?

	Company X	Company Z
Sales	$110,000	$110,000
Cost of Goods Sold	$49,500	$60,000
Net Income	$27,750	$17,250
Inventory	$21,000	$10,500
Current Assets	$64,000	$53,500
Current Liabilities	$22,000	$22,000

Answer 1

(1)

return on sales = net income/sales

for company X,

= $27750/$110000 = 25.23%

for company Z,

= $17250/$110000 = 15.68%

(2)

inventory turnover = cost of goods sold/average inventory

for company X,

= $49500/$21000 = 2.36 times

for company Z,

= $60000/$10500 = 5.71 times

(3)

Invemtory on hand period = days in year/inventory turnover

for company X,

= 365/2.36 = 155 days

for company Z,

= 365/5.71 = 64 days

(4)

current ratio = current assets/current liabilities

for company X,

= $64000/$22000 = 2.91 times

for company Z,

= $53500/$22000 = 2.43 times

(5)

Company X is better for investment beacause even though its inventory turnover is low, its return on sales and current ratio are higher than company Z