Question 1

$$\begin{array} { l r r } 
\text { Operating assets } & \underline { 2005 } & \underline { 2004 } \
\text { Short-term debt } & 10,500 & \$ 10,000 \
\text { Long-term debt } & 3,5000 & 1,000 \
\text { Minority interest } & 500 & 4,000 \
\text { Common equity } & 5,500 & 5,000 \
& & \
\text { Operating income } & 1,350 & \
\text { Interest expense } & 350 & \
\text { Tax expense } ( 40 \% ) & 400 & \
\text { Minority interest } & 50 & \
\text { Net income } & 550 &
\end{array}$$
-Return on common equity for 2005 is:

Accepted Answer

A) 11.42%. 
B) 10.0%. 
C) 11.0%. 
D) 10.47%.

Question 2

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

Accepted Answer

A) Switching from straight line to accelerated depreciation for financial reporting purposes 
B) An increase in the financial leverage of the company 
C) Addition of a new plant for production purposes 
D) Decrease cost of production inputs

Question 3

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.

Accepted Answer

A) True 
 B)False

Question 4

The following information relates to Yutter Corporation:
 $\begin{array}{lr}&\text { Year } 1\
\text { Net income-year ended } 12 / 31 & \$ 12,500 \
\text { Dividends } & 3,000 \
\text { Return on net operating assets } & 13 \% \
\text { Return on equity } & 15 \% \
\text { Cost of equity } & 12 \%
\end{array}$
-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?

Accepted Answer

A) $83,333 
B) $157,642 
C) $500,000 
D) $557,000

Question 5

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

Accepted Answer

A) Widget uses straight-line depreciation and Tool uses MACRS. 
B) Widget uses LIFO and Tool uses FIFO. 
C) Tool has foreign subsidiaries in countries with much lower tax rates. 
D) Widget has significant amounts of interest income from municipal bonds.

Question 6

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

Accepted Answer

A) True 
 B)False

Question 7

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.

Accepted Answer

A) True 
 B)False

Question 8

$$\begin{array} { l r r } 
& \underline { 2006 } & \underline { 2005 } \
\text { Current assets } & \$ 4,650 & \$ 4,730 \
\text { Long-term assets } & 7,120 & 6,450 \
\text { Current liabilities } & 1,440 & 1,340 \
\text { Long-term debt } & 3,830 & 3,760 \
\text { Common equity } & 6,500 & 6,080 \
& & \
\text { Operating income } & 2,140 & \
\text { Interest expense } & 240 & \
\text { Tax expense } ( 40 \% ) & 760 & \
\text { Net income } & 1,140 &
\end{array}$$
Assume all assets are operating assets; all current liabilities are operating liabilities. 
-Return on equity for 2006 is:

Accepted Answer

A) 20.41%. 
B) 19.75%. 
C) 17.54%. 
D) 18.12%.

Question 9

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

Accepted Answer

A) Profitability 
B) Efficiency 
C) Solvency 
D) Liquidity

Question 10

Selected information for Acme Corp.:
 $\begin{array}{lrrr}&\text { Year } 1&\text { Year } 2&\text { Year } 3\
\text { Cash } & \$ 1,000 & \$ 1,500 & \$ 1,500 \
\text { Marketable securities } & 8,000 & 2,000 & 2,000 \
\text { Accounts receivable, net } & 2,000 & 3,000 & 2,500 \
\text { Other current assets } & 2,500 & 3,000 & 3,000 \
\text { Property, plant, and equipment } & 4,500 & 6,000 & 7,000 \
\text { Less: accumulated depreciation } & (4,000) & (4,200) & (4,400) \
\text { Goodwill and other intangibles } & 5,000 & 7,500 & 1,000
\end{array}$
-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?

Accepted Answer

A) Accumulated depreciation adjustment 
B) Intangible asset adjustment 
C) Non-operating asset adjustment 
D) No asset adjustment

Question 11

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.

Accepted Answer

A) True 
 B)False

Question 12

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

Accepted Answer

A) Widget Co's lower financial leverage 
B) Widget Co uses FIFO and Tools uses LIFO 
C) Widget Co's lower tax rate 
D) Widget Co has significant operating leases and Tool Inc. has no leases

Question 13

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

Accepted Answer

A) True 
 B)False

Question 14

Selected information for Acme Corp.:
 $\begin{array}{lrrr}&\text { Year } 1&\text { Year } 2&\text { Year } 3\
\text { Cash } & \$ 1,000 & \$ 1,500 & \$ 1,500 \
\text { Marketable securities } & 8,000 & 2,000 & 2,000 \
\text { Accounts receivable, net } & 2,000 & 3,000 & 2,500 \
\text { Other current assets } & 2,500 & 3,000 & 3,000 \
\text { Property, plant, and equipment } & 4,500 & 6,000 & 7,000 \
\text { Less: accumulated depreciation } & (4,000) & (4,200) & (4,400) \
\text { Goodwill and other intangibles } & 5,000 & 7,500 & 1,000
\end{array}$
-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?

Accepted Answer

A) Accumulated depreciation adjustment 
B) Tangible asset adjustment 
C) Non-operating asset adjustment 
D) No asset adjustment

Question 15

Below is selected information from Tricrop. $\begin{array}{lll}
&\underline{\text { Year } 1} &\underline{\text { Year } 2}\
\text { Net operating assets/common equity } & 1.37 & 1.53 \
\text { Net operating profit margin } & 19 \% & 21 \% \
\text { Income tax rate } & 47 \% & 28 \% \
\text { Revenues/average net operating } & 0.81 & 0.61 \
\text { assets } & & \
\text { EBIT/revenues } & 38 \% & 32 \%
\end{array}$
-Return on common equity for Year 1 is:

Accepted Answer

A) 19.0%. 
B) 19.60%. 
C) 21.08%. 
D) 26.03%.

Question 16

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

Accepted Answer

A) A decrease in interest rate on debt 
B) Increase in days accounts receivable are outstanding 
C) Increase in inventory turnover 
D) Decrease in gross margin

Question 17

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

Accepted Answer

A) the sustainable equity growth rate would increase. 
B) the return on equity would decrease. 
C) the value of the stock would decrease. 
D) the return on net operating assets would decrease.

Question 18

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

Accepted Answer

A) Increase in the return on net operating assets 
B) Decrease in the return on net operating assets 
C) No change in the return on net operating assets 
D) There is not sufficient information

Question 19

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.
$$\begin{array} { l r r } 
& \text { NOPAT margin } & \text { Net operating asset turnover } \
\text { Industry A } & 8.0 \% & 1.5 \
\text { Industry B } & 1.2 \% & 5.5 \
\text { Industry C } & 5.4 \% & 1.0
\end{array}$$ 
Match the industry to A, B or C

$\begin{array}{lll}&\text { Grocery Retail } & \text { Oil and Gas } & \text { Drug } \
A.&\text { B } & \text { C } & \text { A } \
B.&\text { B } & \text { A } & \text { C } \
C.&\text { C } & \text { A } & \text { B } \
D.&\text { C } & \text { B } & \text { A }
\end{array}$

Accepted Answer

A) Option A 
B) Option B 
C) Option C 
D) Option D

Question 20

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.

Accepted Answer

The answer of You are comparing the Return on Common...

Exam 8: Return on Invested Capital and Profitability Analysis

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.

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.

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

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.

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

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

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