Question

ratio comparisons robert arias recently inherited a stock portfolio from his uncle. wishing to learn more about the companies in which he is now invested, robert performs a ratio analysis on each one and decides to compare them to one another. some of his ratios are listed here. assuming that his uncle was a wise investor who assembled the portfolio with care, robert finds the wide differences in these ratios confusing. help him out.
a. what problems might robert encounter in comparing these companies to one another on the basis of their ratios?
b. why might the current and quick ratios for the electric utility and the fast - food stock be so much lower than the same ratios for the other companies?
c. why might it be all right for the electric utility to carry a large amount of debt, but not the software company?
d. why wouldnt investors invest all of their money in software companies instead of in less profitable companies? (focus on risk and return.)
a. what problems might robert encounter in comparing these companies to one another on the basis of their ratios? (select all the answers that apply.)
a. financial ratios from software companies are never very reliable.
b. the four companies are in very different industries.
c. the operating characteristics of firms across different industries vary significantly resulting in very different ratio values.
d. caution must be exercised when comparing older to newer firms, e.g., utility company vs. software company.
data table
(click the icon here in order to copy the contents of the data table below into a spreadsheet.)

ratio	island electric utility	burger heaven	fink software	roland motors
quick ratio	0.93	0.81	5.21	3.66
debt ratio	0.66	0.48	0.02	0.38
net profit margin	6.17%	14.31%	28.52%	8.44%

Explanation:

a. Comparing companies based on ratios can be problematic when they are from different industries as operating characteristics vary (B, C). Also, differences in firm - age (older vs newer) can affect ratios (D). Financial ratios of software companies are not inherently unreliable, so A is incorrect.
b. Electric utility and fast - food stocks may have lower current and quick ratios as they may have more fixed assets and less liquid current assets compared to software and motor companies. Utilities have long - term infrastructure and fast - food has inventory that may not be as liquid.
c. Electric utilities have stable cash flows from essential services, so they can handle large debt. Software companies have more volatile cash flows due to rapid technological changes and competition, making high debt riskier.
d. Investors don't put all money in software companies as they are riskier. There is a higher chance of technological obsolescence and intense competition. Less profitable companies may offer more stable returns and act as a diversification tool to reduce overall portfolio risk.

Answer:

a. B. The four companies are in very different industries.
C. The operating characteristics of firms across different industries vary significantly resulting in very different ratio values.
D. Caution must be exercised when comparing older to newer firms, e.g., utility company vs. software company.
b. Electric utility and fast - food stocks may have more fixed assets and less liquid current assets.
c. Electric utilities have stable cash flows while software companies have volatile cash flows.
d. Software companies are riskier; diversification reduces overall portfolio risk.