Answer to Question #198222 in Economics for Heather Creed

Question

The following information is given with respect to the ratios of two companies

Aman Ltd Roger Ltd

Current Ratio 2:01 1.60:1

Quick Ratio 1.35:1 1:01

Return on

investment 15% 13%

Debt equity

ratio 2.5:1 1:01

a. Define the concepts of Current and Quick ratio’s and also, reflect on your understanding towards the financial performance of the companies by looking to the above information (2marks for defining and 3 marks for interpretation and reasoning) (5 Marks) 

b. Define the terms- Return on Investment and Debt equity ratio and also, reflect on your understanding towards the financial performance of the companies (2marks for defining and 3 marks for interpretation and reasoning) (5 Marks) 

Answer 1

a. The current ratio is a liquidity ratio that’s used by investors to determine whether a company is capable of paying off all of its current liabilities using its current assets.

Current ratio = current assets ÷ current liabilities

Ideally, the current ratio of a company should be more than 1.

So, both companies have good current ratio.

The quick ratio, on the other hand, is another liquidity ratio that’s typically used by investors to determine how efficient a company is at paying off all of its current liabilities using its current assets.

Quick ratio = (cash + cash equivalents + current receivables + short-term investments) ÷ current liabilities.

Preferably, the quick ratio of a company should also be more than 1.

So, both companies have high enough current ratio.

b. Return on investment (ROI) is a performance measure used to evaluate the efficiency or profitability of an investment or compare the efficiency of a number of different investments.

To calculate ROI, the benefit (or return) of an investment is divided by the cost of the investment. ROI should be possitive.

Aman Ltd has better ROI.

The debt-to-equity (D/E) ratio is used to evaluate a company's financial leverage and is calculated by dividing a company’s total liabilities by its shareholder equity.

Higher leverage ratios tend to indicate a company or stock with higher risk to shareholders.

Roger Ltd has better debt-to-equity ratio.