Exam 8: Return on Invested Capital and Profitability Analysis

Which of the following ratios best measures the profitability of a company?

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

Niglow Corporation produces metal castings. In the past year it earned a 10% return on its net operating assets base of $10M. Niglow needs $10M to expand its operations, and has the option of obtaining none, some, or all of the proceeds from the bank. Currently the company is all equity financed. It expects to be able to maintain its return on net operating assets after the expansion. The bank has indicated that the amount it will charge on the loan will be dependent upon the resultant debt/equity ratio. Specifically, the rates will be 8%, 9%, 10% and 12% for debt to equity ratios less than or equal to 0.25, 0.5, 1.0 and over 1.0, respectively. Niglow's tax rate is 40%. b. Calculate Niglow's return on common equity if the expansion is financed: i. using all equity ii. 50% debt, 50% equity iii. all debt c. What would Niglow's return on net operating assets need to be for the return on equity to be decreased by financing the expansion using all debt.

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

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 could explain the difference in observed tax rates?

Purchases divided by accounts payable provides information about:

If two companies both increase their net income by 25% over the prior year this means they have both been equally profitable this year.

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. ABC uses FIFO and XYZ uses LIFO (assuming normal economic conditions) ABC sold receivables at face value at the end of the year.

An increase in net operating income (NOPAT) will cause which of the following?

Companies that have low net operating profit margins generally only earn a reasonable return on net operating assets if they can utilize their net operating assets very efficiently.

Long-term debt 7,709 8,508 Long-term obligations under capital leases 2,307 2,092 Deferred income taxes and other 463 400 Minority interest 1,025 331 Shareholders' equity: Preferred stock (\ 10 par value, 100 shares authorized, none issued) Common stock (\ .10 par value, 5,500 shares authorized, 2,285 and 2,293 issued and outstanding in X6 and X 7, respectively) 228 229 Capital in excess of par value 547 545 Retained earnings 16,768 14,394 Foreign currency translation adjustment (412) Total shareholders' equity Total liabilities and shareholders' equity \ 39,604 \ 37,541 a. Calculate return on common equity (ROCE) for fiscal X4 and X7. Identify, as far as allowed by the data, components driving any changes in ROCE from X4 to X7. (If you want to give students more guidance then ask to disaggregate ROCE into net operating profit margin, net operating asset turnover and leverage.) b. Compare and contrast the change in earnings per share to ROCE over this time period.

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 Yutter's sustainable equity growth rate?

Which of the following statements is correct?

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 best explains the difference in observed net operating asset turnovers?

When calculating return on total equity it is normal to add back preferred dividends to net income.

Operating assets \ 10,500 \ 10,000 Short-term debt 1,000 1,000 Long-term debt 3,500 3,000 Minority interest 500 450 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: