# How is this determined?? -From Mock exam

The following data is available on two companies that operate in the same industry:

Metric (\$ millions)

Company X

Company Y

Sales

11.2

14.5

Cost of goods sold

5.7

7.7

1.9

2.2

Interest expense

0.3

0.7

Research & development expenses

1.5

1.7

Which of the following statements is most appropriate? Better margin performance will be reported by:

Y at the gross margin level and X at the operating margin level. Y at both the gross margin and operating margin levels. X at the gross margin level and Y at the operating margin level. Question not answered

Common size statements offer a convenient way to compare companies of different magnitudes. Company X reports better (higher) gross margin performance. Company Y reports better (higher) operating margin performance.

Metric (common size)

Company X

Company Y

Comparison

Sales

100%

100%

Cost of goods sold

51

53

Gross margin (GM)

49

47

X’s GM is higher

17

15

Research & development expenses

13

12

Operating margin (OM)

19

20

Y’s OM is higher

CFA Level I

How did they get the 51 (COGS X) and the other numbers in the 2nd chart? This common size statement is tripping me up for some odd reason…

Answer is C. Just calcualte the gross and operating margin ratios and compare them. Gross Margin (Sales-COGS)/Sales. Operating Margin = (Sales-COGS-Admin-R&D)/Sales

Using the common size gives you the answers - the figures in the common size are as a % of sales. Therefore COGS X = COGS/Sales = 5.7/11.2 = 51%.