Accounting: What the Numbers Mean 9th Edition by Wayne W McManus, Daniel F Viele, David H Marshall

Exercise 62

Analytical case—comparative analysis of profitability and financial leverage measures The annual reports of the Coca-Cola Co. and PepsiCo, Inc., indicate the following for the year ended December 31, 2008 (amounts in millions):

	Coca-Cola Co.	PepsiCo., Inc.
Net revenues	$31,994	$43,251
Net income	5,807	5,142
Total assets, January 1, 2008	43,269	34,628
Total liabilities, January 1, 2008	21,525	17,394
Total liabilities, December 31, 2008	20,047	23,888
Total stockholders’ equity, December 31, 2008	20,472	12,203

Required:

a.Calculate ROI and ROE for each company for 2008. (Hint: You will need to calculate some of the numbers used in the denominator of these ratios.)

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b. Based on the results of your ROI and ROE analysis in part a, do you believe that either firm uses financial leverage more effectively than the other? Explain your answer. (Hint: Compare the percentage differences between ROI and ROE for each firm. Is there a significant difference that would suggest that one firm uses leverage more effectively than the other?)

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c. Calculate the debt ratio and debt/equity ratio for each firm at the end of 2008.

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d. Compare the results of your analysis in part c to your expectations concerning the relative use of financial leverage in part b. Do the debt and debt/equity ratios calculated in part c make sense relative to your expectations? Explain your answer.

Step 1 of 9

Comparative analysis of financial leverage and profitability measures

Financial leverage : This measure describes the extent to which an investor or company is utilizing borrowed funds. Debt and debt/equity ratios are the part of financial leverage measures.

Profitability measures: A set of financial metrics that are helpful in assessing a company's ability to generate profits as compared to its costs and other relevant expenses incurred during a particular period of time. ROI and ROE are the part of profitability measures.