Question

Assume that two firms have the same operating profit margin of 35%. Firm A has a net profit margin of 9%, however, while Firm B has a net profit margin of 12%. Which of the following is the probable reason for this?

All choices are possible reasons

Firm A has a higher cost of goods sold than Firm B

Firm A has more interest expense than Firm B

Firm A has more depreciation and amortization expense than Firm B

Answer 1

Option (c) is correct.

Operating margin is earnings before interest and taxes (EBIT). Operating margin for both the companies is same at 35%.

When we calculate net profit or net income then we deduct interest expense and taxes from EBIT or operating profit.Means:

Net income or Net profit = EBIT or operating profit - Interest expense - Tax

Now, in the question, till operating profit, both firms are earning same percentage of 35%. But, when it come to net profit, firm A's margin (9%) has reduced in comparison to firm B's(12%). So by looking at the above equation of net profit it can be clearly said that firm A has incurred more interest expense than firm B, which is the reason that firm B's net profit margin is higher.