Exam 8: Return on Invested Capital and Profitability Analysis

Below are selected ratios for Widget Corporation and Tools Inc. Use this information answer the following questions. Year 1 Year 2 Year 3 1. Net operating asset turnover 1.4 1.31 1.25 2. Inventory turnover 5.6 5.0 4.6 3. Accounts receivable turnover 12.1 11.9 12.1 4. Fixed assets turnover 1.3 1.29 1.29 5. Net operating profit margin 4.5\% 4.6\% 4.8\% 6. Net operating assets/equity 2.10 1.98 1.77 7. EBIT/revenues 8.9\% 8.6\% 8.6\% 8. Gross margin 20.1\% 19.9\% 19.8\% 9. Income tax rate 35\% 35\% 35\% a. We know from the residual income method of valuation that, all other things equal, the company with the higher ROCE will have a higher intrinsic value. b. Why are all other things not likely to be equal in this instance (hint: look at components of ROCE)? c. Which company has better operating performance (that is, ignoring capital structure).

2006 1005 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 net operating assets for 2005 is:

Selected information for Acme Corp.: Year 1 Cash 1,000 Marketable securities 8,000 Occounts receivable-net 2,000 Other current assets 2,500 Property, plant and equipment 4,500 Less: accumulated depreciation (4,000) Gess: accumulated depreciation 5,000 Year 2 Year 3 1,500 1,500 2,000 2,000 3,000 2,500 3,000 3,000 6,000 7,000 (4,200) (4,400) 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?

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

The following information relates to Yutter Corporation Year 1 Net income-year ended 12/31 \1 2,500 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?

If future expected return on common stockholders' equity is less than expected required return by equity holders then the market value of a company's stock should be less than book value.

Which of the following is correct concerning changes at Tricrop from Year 1 to Year 2? RNOA ROCE A) Increased Increased B) Increased Decreased C) Decreased Decreased D) Decreased Increased

Err Company has a major lawsuit against them for unsafe products. It recognizes a huge liability in 2004 of $300M. The effect of this liability is to decrease stockholders' equity by 50%. In 2005, the effect of recognizing this liability, all else equal, is:

Practice considers a segment significant if its sales, operating income (or loss), or identifiable assets are 30% or more of the combined amounts of all the company's operating assets.

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

2006 1005 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 2005 is:

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.

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/net operating assets 0.81 0.61 EBIT/revenues 38\% 32\% -Return on Net Operating Assets for Year 1 is:

It is possible to have increasing earnings growth while having decreasing return on net operating assets.

Return on net operating assets will always be greater than or equal to the pre-tax return on equity.

When calculating return on net operating assets, deferred taxes should be deducted from the denominator.

WidgetCo and Tools Inc. both operate in the same industry. They are capital-intensive companies producing widgets. Below are selected data WidgetCo Tools 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 is the most plausible explanation of the difference in observed net operating profit margins?

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/net operating assets 0.81 0.61 EBIT/revenues 38\% 32\% -Return on Common Equity for Year 1 is:

Which of the following situations is most likely to explain a net operating asset turnover that is higher than the industry norm?

Below are selected ratios for Manufacturers Corporation. Use this information answer the following questions. 田 Year 1 Year 2 Year 3 1. Net operating asset turnover 1.4 1.31 1.25 2. Inventory turnover 5.6 5.0 4.6 3. Accounts receivable turnover 12.1 11.9 12.1 4. Fixed assets turnover 1.3 1.29 1.29 5. Net operating profit margin 4.5\% 4.6\% 4.8\% 6. Net operating assets/equity 2.10 1.98 1.77 7. EBIT/revenues 8.9\% 8.6\% 8.6\% 8. Gross margin 20.1\% 19.9\% 19.8\% 9. Income tax rate 35\% 35\% 35\% a. Calculate return on net operating assets for all three years. Identify reasons for any changes. b. Calculate return on equity for all three years. Comment on changes.