Exam 8: Return on Invested Capital and Profitability Analysis

Operating assets Short-term debt 10,500 \ 10,000 Long-term debt 3,5000 1,000 Minority interest 500 4,000 Common equity 5,500 5,000 Operating income 1,350 Interest expense 350 Tax expense (40\%) 400 Minority interest 50 Net income 550 -Return on common equity for 2005 is:

Which of the following could explain a decrease in net operating asset turnover for a company?

A company that operates in a highly competitive industry with low barriers to entry is likely to have low net operating profit margins compared to companies that operate in less competitive industries.

The following information relates to Yutter Corporation: Year 1 Net income-year ended 12/31 \ 12,500 Dividends 3,000 Return on net operating assets 13\% Return on equity 15\% Cost of equity 12\% -What is the value of Yutter's stock at the end of Year 1 using the dividend discount model assuming that the dividend payout ratio remains constant and Yutter grows at its sustainable equity growth rate?

Widget Co. and Tools Inc. both operate in the same industry. They are capital-intensive companies producing widgets. Below are selected data: Widget Co. Tools Inc. Net operating assets/common equity 1.37 1.53 Net operating profit margin 19\% 21\% Income tax rate 47\% 28\% Revenues/net operating assets 0.81 0.61 EBIT/revenues 38\% 32\% -Which of the following statements could explain the difference in observed tax rates?

Financial statements of a diversified company should be analyzed by segments.

Return on net operating assets is a better measure of operating performance than return on equity, as it is independent of the form of financing.

Current assets \ 4,650 \ 4,730 Long-term assets 7,120 6,450 Current liabilities 1,440 1,340 Long-term debt 3,830 3,760 Common equity 6,500 6,080 Operating income 2,140 Interest expense 240 Tax expense (40\%) 760 Net income 1,140 Assume all assets are operating assets; all current liabilities are operating liabilities. -Return on equity for 2006 is:

Return on operating assets is a measure of which of the following?

Selected information for Acme Corp.: Year 1 Year 2 Year 3 Cash \ 1,000 \ 1,500 \ 1,500 Marketable securities 8,000 2,000 2,000 Accounts receivable, net 2,000 3,000 2,500 Other current assets 2,500 3,000 3,000 Property, plant, and equipment 4,500 6,000 7,000 Less: accumulated depreciation (4,000) (4,200) (4,400) Goodwill and other intangibles 5,000 7,500 1,000 -When calculating Acme's return on net operating assets in Year 1, which of the following adjustments to the asset base is most appropriate to consider?

A decrease in net operating profit margin will cause both return on net operating assets and return on equity to decrease, all other things being equal.

Widget Co. and Tools Inc. both operate in the same industry. They are capital-intensive companies producing widgets. Below are selected data: Widget Co. Tools Inc. Net operating assets/common equity 1.37 1.53 Net operating profit margin 19\% 21\% Income tax rate 47\% 28\% Revenues/net operating assets 0.81 0.61 EBIT/revenues 38\% 32\% -Which of the following statements best explains the difference in observed net operating asset turnover?

It is possible to assess the common equity growth rate by analyzing the retention of earnings.

Selected information for Acme Corp.: Year 1 Year 2 Year 3 Cash \ 1,000 \ 1,500 \ 1,500 Marketable securities 8,000 2,000 2,000 Accounts receivable, net 2,000 3,000 2,500 Other current assets 2,500 3,000 3,000 Property, plant, and equipment 4,500 6,000 7,000 Less: accumulated depreciation (4,000) (4,200) (4,400) Goodwill and other intangibles 5,000 7,500 1,000 -When calculating Acme's return on net operating assets in Year 2, which of the following adjustments to the asset base is most appropriate to consider?

Below is selected information from Tricrop. Net operating assets/common equity 1.37 1.53 Net operating profit margin 19\% 21\% Income tax rate 47\% 28\% Revenues/average net operating 0.81 0.61 assets EBIT/revenues 38\% 32\% -Return on common equity for Year 1 is:

Which of the following could cause return on net operating assets to increase, all other things equal?

The following information relates to Yutter Corporation: Year 1 Net income-year ended 12/31 \ 12,500 Dividends 3,000 Return on net operating assets 13\% Return on equity 15\% Cost of equity 12\% -If Yutter's dividend payout ratio increased to 50% after year 1 then:

Which of the following will cause an increase in net operating income (NOPAT)?

Below are the net operating asset turnovers and net operating profit margins for companies that operate in three different industries (A, B and C). The industries are grocery stores, oil extraction and drug industry. NOPAT margin Net operating asset turnover Industry A 8.0\% 1.5 Industry B 1.2\% 5.5 Industry C 5.4\% 1.0 Match the industry to A, B or C Grocery Retail Oil and Gas Drug A. B C A B. B A C C. C A B D. C B A

You are comparing the Return on Common Equity (ROCE) and its components (net operating profit margin, net operating asset turnover and leverage) of two companies in the same industry, ABC Corp and XYZ Corporation. Explain how each of the following will affect of ROCE and its components of ABC relative to XYZ, all other things equal. 1. ABC Corporation is 100% equity financed, whereas XYZ has a significant amount of debt financing. 2. ABC issued stock dividend during year, and XYZ did not. 3. ABC uses FIFO and XYZ uses LIFO (assuming normal economic conditions) 4. ABC sold receivables at face value at the end of the year.