The gross profit is the difference of total revenue and total cost of products and services. In 1998, the gross profit was $7.19 billion, and in 1997, it was $6.75 billion and in 1996, it was $5.15 billion. Due to lack of information, other profitability ratios can not be determined such as the current ratio, quick ratio, ROE and ROI. The total revenue has increased by approximately 5 billion each year. Cost for services has increased six fold from 1996 to 1998, while the cost of products has gone down steadily.
The increase in cost of services overshadows the decrease in cost of products. Thus, the percentage in cost of sales has increased causing a decrease in gross profit from 1997 to 1998, whereas, in 1996 to 1997, the percentage in cost of sales has decrease causing an increase in gross profit. In 1996 and 1997 the percentage of moneys used in research and development averaged 3.4% of total revenue. In 1998 research and development increased to 4.4% of total revenue. This translated to an increase of $536 million. In 1998 with the acquisition of Digital Compaq acquired approximately $3.2 billion in obsolete technology.
To keep up with competitors Compaq had to allocate more money for research and development, which ought to lead to greater returns in the future. In 1996 and 1997 the gross profit was greater then the total operating expenses therefore positive incomes of $2.75 billion (1997) and $1.88 billion (1996) resulted. However, in 1998 operating expenses exceeded gross profit resulting in a $2.66 billion loss. This loss was due to an increase in research and development, restructuring costs after the acquisition, asset impairments, and purchasing other technologies.
The loss would have resulted in a federal tax return of $932 million and a foreign tax return of 40 million, however Compaq had to pay a US statutory 35% tax on the purchase of $3.2 billion of in-process technology. This required tax consumed their federal and foreign tax return plus $81 million. The acquisition of Digital by Compaq seems to be a poor choice. This opinion is based on 2 facts. First Compaq had to spend an additional $286 million in restructuring cost above what had been previously anticipated. Secondly, when Compaq bought Digital they acquired $3.2 billion in obsolete technologies.
These 2 negative aspects of the purchase of Digital resulted in a horrible 1998. However, there has to be a good reason why Compaq purchased digital. Most likely, the positive future long-term gains should overshadow the short-term losses associated with the buy out. Bibliography Ormiston, Aileen. Understandind Financial Statements, Sixth Ediditon.