Solution for Business Analysis and Valuation: Text and Cases 1st Edition Chapter 5, Problem 1

by Paul M., Palepu, Krishna G., Peek, Erik Healy
179 Solutions 11 Chapters 43157 Studied ISBN: 9781408056424 Accounting 5 (1)

Chapter 5, Problem 1 : 1. Which of the following types of firms...

1. Which of the following types of firms do you expect to have particularly high or low asset turnover? Explain why.

Step-By-Step Solution

1. Supermarket—High asset turnover. Supermarkets tend to be high volume businesses. Many of the food products in supermarkets are perishable, and freshness is often used to differentiate products, forcing a certain amount of inventories turnover. The typical consumer buys groceries on a regular basis, guaranteeing grocery stores a certain level of overall business. Apart from inventories, a supermarket’s largest assets are its warehouses and stores, all constructed to be relatively inexpensive. Thus, high sales volumes generate a high measured level of asset turnover.

Pharmaceutical Company—High asset turnover. Drugs typically have a limited shelf-life. Once past their expiration date, drugs cannot be sold and are worthless. Consequently, pharmaceutical companies try to limit production to quantities which can be expected to be sold before the expiration date. A pharmaceutical company’s assets are relatively low for two reasons. First, its investment in research and development is expensed rather than recorded as an asset on the company’s books. Second, patents do not typically show up as assets on the pharmaceutical company’s books. Thus, high sales combined with lower reported asset levels generate a high measured level of asset turnover.

Jewelry Retailer—Low asset turnover. Jewelry is typically durable, expensive, and infrequently purchased by most consumers. Jewelry is also a strongly differentiated product. A single jewelry store may carry over 150 different styles of watches. The consumer will choose one watch from among the entire selection. Hence, the jewelry store must maintain a large inventory to support its sales. Because the jewelry store’s main asset is inventory, which has a slow rate of turnover, the typical jewelry store will show low asset turnover.

Steel Company—Low asset turnover. Production of steel is extremely asset intensive. A steel company will invest hundreds of millions of euros in property, plant, and equipment necessary to manufacture steel. Moreover, steelmaking equipment has a useful lifetime measured in decades. Relative to this enormous investment, a steel company’s sales will be low. Consequently, a steel company will typically have low asset turnover.

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