Exercise 12-13 Name:
Insert your answers into the gray-shaded cells. Insert formulas in the answer cells
of the table. If an answer is incorrect, the word “wrong will appear.
Firm A
Industry
Average
Net income 27% 10%
Advertising 2% 17%
R&D 8% 25%
Facilities investment 10% 25%
Spending as a Percentage of Sales
Two observations arise from an examination of the data. First, Firm A is
generating more profit per dollar of sales than is the average firm in the industry.
Although the average firm generates profit equal to 10 percent of sales ($0.096 ÷
$0.96), Firm A’s profits are a whopping 27 percent of sales ($0.54 ÷ $2). Second,
relative to its sales, Firm A is spending much less on advertising, R&D, and
investment in new facilities. While one interpretation of the data is that Firm A is
much more profitable than the average firm in the industry because it is more
effectively managing its costs, the opposite is likely true. Firm A is robbing from
its future to increase the current level of profits. Unless Firm A starts investing
much more heavily in the three areas featured in the problem, the firm will start to
lose market share, sales will drop, and profits will decline dramatically. Another
possibility is that Firm A is engaging in fraudulent financial reporting.
Solution