How would combining two companies with differing profit ratios effect the new average profitability? Would this be favorable?© BrainMass Inc. brainmass.com June 3, 2020, 8:32 pm ad1c9bdddf
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How would combining two companies with differing profit ratios effect the new average profitability? Would this be favorable?
Profit ratio= Net Profit/Sales
It shows the operational efficiency of the business. The two companies having different profit ratios say A is having 20% and B is having 10% and assuming equal sales of both then the merged entity profit will be 15%. Hence in percentage terms it will be less than the A, but one should compare the margin with the cost of capital. If the profit margin is more than the cost of capital than it is acceptable. Here the concept of EVA can be applied.
EVA measures whether the operating profit is enough compared to the total costs of capital employed. Stewart defined EVA as Net operating profit after taxes (NOPAT) subtracted with a capital charge. ...
This solution helps to determine how profit ratios affect average profitability.