Question

Company 1 has return on assets of 8.2% and a debt to equity ratio of 67.2%. Company 2 has return on assets of 6.3% and a debt to equity ratio of 53.4%. Based on these ratios, what is generally true about these two companies?

a. Company 1 has lower profitability and higher risk.
b. Company 1 has higher profitability and higher risk.
c. Company 1 has lower profitability and lower risk.
d. Company 1 has higher profitability and lower risk.

Answer 1

Option b is the correct answer. Company 1 has a higher return on assets of 8.2%, indicating higher profitability, and a higher debt to equity ratio of 67.2%, indicating higher risk, compared to Company 2.

Step-by-step explanation:

Based on the financial ratios provided for Company 1 and Company 2, we can evaluate their profitability and risk. The return on assets (ROA) indicates how efficiently a company is using its assets to generate profit. With Company 1's ROA at 8.2% compared to Company 2's 6.3%, it is clear that Company 1 is more profitable. On the other hand, the debt to equity ratio is a measure of financial risk, showing the proportion of a company's funding that comes from debt relative to equity. Company 1 has a higher debt to equity ratio of 67.2% versus Company 2's 53.4%, indicating that Company 1 has higher financial leverage, thus higher risk.

Therefore, the accurate answer to the question is: b. Company 1 has higher profitability and higher risk.