Question 1

Below are selected ratios for Widget Corporation and Tools Inc. Use this information answer the following questions. $$\begin{array} { | l | l | r | r | r | } 
\hline & & \text { Year 1 } & \text { Year 2 } & \text { Year 3 } \
\hline \text { 1. } & \text { Net operating asset turnover } & 1.4 & 1.31 & 1.25 \
\hline 2 . & \text { Inventory turnover } & 5.6 & 5.0 & 4.6 \
\hline 3 . & \text { Accounts receivable turnover } & 12.1 & 11.9 & 12.1 \
\hline 4 . & \text { Fixed assets turnover } & 1.3 & 1.29 & 1.29 \
\hline 5 . & \text { Net operating profit margin } & 4.5 \% & 4.6 \% & 4.8 \% \
\hline 6 . & \text { Net operating assets/equity } & 2.10 & 1.98 & 1.77 \
\hline \text { 7. } & \text { EBIT/revenues } & 8.9 \% & 8.6 \% & 8.6 \% \
\hline 8 . & \text { Gross margin } & 20.1 \% & 19.9 \% & 19.8 \% \
\hline 9 . & \text { Income tax rate } & 35 \% & 35 \% & 35 \% \
\hline
\end{array}$$ 
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).

Accepted Answer

The answer of Below are selected ratios for Widget Corporation...

Question 2

$$\begin{array} { | l | r | r | } 
\hline & { 2006 } &{ 1005 } \
\hline \text { Current assets } & \$ 4,650 & \$ 4,730 \
\hline \text { Long-term assets } & 7,120 & 6,450 \
\hline \text { Current liabilities } & 1,440 & 1,340 \
\hline \text { Long-term debt } & 3,830 & 3,760 \
\hline \text { Common equity } & 6,500 & 6,080 \
\
\hline \text { Operating income } & 2,140& \
\hline \text { Interest expense } & 240 & \
\hline \text { Tax expense } ( 40 \% ) &  760& \
\hline \text { Net income } & 1,140 & \
\hline
\end{array}$$ Assume all assets are operating assets; all current liabilities are operating liabilities.
-Return on net operating assets for 2005 is:

Accepted Answer

A)  11.30% 
B)  12.73% 
C)  9.93% 
D)  11.19%

Question 3

Selected information for Acme Corp.:
 $\begin{array}{c}
\begin{array}{|l|c|}
\hline & \text { Year 1 } \
\hline \text { Cash } & 1,000 \
\hline \text { Marketable securities } & 8,000 \
\hline \text { Occounts receivable-net } & 2,000 \
\hline \text { Other current assets } & 2,500 \
\hline \text { Property, plant and equipment } & 4,500 \
\hline \text { Less: accumulated depreciation } &(4,000)\
\hline \text { Gess: accumulated depreciation } &  5,000\
\hline
\end{array}
\begin{array}{c|c|}
\hline
\text { Year 2 } & \text { Year 3 } \
\hline 1,500 & 1,500 \
\hline 2,000 & 2,000 \
\hline 3,000 & 2,500 \
\hline 3,000 & 3,000 \
\hline 6,000 & 7,000 \
\hline(4,200) & (4,400) \
\hline 7,500 & 1,000\
\hline
\end{array}
\end{array}$
-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)  Nonoperating asset adjustment 
D)  No asset adjustment

Question 4

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

Accepted Answer

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

Question 5

The following information relates to Yutter Corporation
 $$\begin{array} { | l | c | }
\hline &\text { Year 1 } \ 
\hline \text { Net income-year ended } 12 / 31 &  \$12,500\
\hline \text { Dividends } &  3,000\
\hline \text { Return on net operating assets } &  13 \%\
\hline \text { Return on equity } &  15 \%\
\hline \text { Cost of equity } &  12 \%\
\hline
\end{array}$$
-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 6

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.

Accepted Answer

A) True 
 B)False

Question 7

Which of the following is correct concerning changes at Tricrop from Year 1 to Year 2? $$\begin{array} { | c | c | c | } 
\hline & \text { RNOA } & \text { ROCE } \
\hline \text { A) } & \text { Increased } & \text { Increased } \
\hline \text { B) } & \text { Increased } & \text { Decreased } \
\hline \text { C) } & \text { Decreased } & \text { Decreased } \
\hline \text { D) } & \text { Decreased } & \text { Increased } \
\hline
\end{array}$$

Accepted Answer

A)  Choice A 
B)  Choice B 
C)  Choice C 
D)  Choice D

Question 8

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:

Accepted Answer

A)  Return on net operating assets will increase dramatically 
B)  Return on net operating assets will decrease dramatically 
C)  Return on equity will increase dramatically 
D)  Return on equity will decrease dramatically

Question 9

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.

Accepted Answer

A) True 
 B)False

Question 10

Which of the following could cause return on net operating assets to increase, all things other 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 11

$$\begin{array} { | l | r | r | } 
\hline & { 2006 } &{ 1005 } \
\hline \text { Current assets } & \$ 4,650 & \$ 4,730 \
\hline \text { Long-term assets } & 7,120 & 6,450 \
\hline \text { Current liabilities } & 1,440 & 1,340 \
\hline \text { Long-term debt } & 3,830 & 3,760 \
\hline \text { Common equity } & 6,500 & 6,080 \
\
\hline \text { Operating income } & 2,140& \
\hline \text { Interest expense } & 240 & \
\hline \text { Tax expense } ( 40 \% ) &  760& \
\hline \text { Net income } & 1,140 & \
\hline
\end{array}$$ Assume all assets are operating assets; all current liabilities are operating liabilities.
-Return on equity for 2005 is:

Accepted Answer

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

Question 12

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 13

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

Accepted Answer

A)  30.8% 
B)  16.3% 
C)  15.4% 
D)  14.5%

Question 14

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

Accepted Answer

A) True 
 B)False

Question 15

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

Accepted Answer

A) True 
 B)False

Question 16

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

Accepted Answer

A) True 
 B)False

Question 17

WidgetCo and Tools Inc. both operate in the same industry. They are capital-intensive companies producing widgets. Below are selected data
 $$\begin{array} { | l | c | c | } 
\hline & \text { WidgetCo } & \text { Tools } \
\hline \begin{array} { l } 
\text { Net operating assets /common } \
\text { equity }
\end{array} & 1.37 & 1.53 \
\hline \text { Net operating profit margin } & 19 \% & 21 \% \
\hline \text { Income tax rate } & 47 \% & 28 \% \
\hline \text { Revenues/net operating assets } & 0.81 & 0.61 \
\hline \text { EBIT/revenues } & 38 \% & 32 \% \
\hline
\end{array}$$
-Which of the following statements is the most plausible explanation of the difference in observed net operating profit margins?

Accepted Answer

A)  WidgetCo's lower financial leverage 
B)  WidgetCo uses LIFO and Tools uses FIFO 
C)  WidgetCo's lower tax rate 
D)  WidgetCo's net operating asset turnover

Question 18

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

Accepted Answer

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

Question 19

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

Accepted Answer

A)  The company has more recently purchased fixed assets 
B)  The company uses FIFO while competitors use LIFO 
C)  The company uses accelerated depreciation method while competitors use straight line 
D)  The company extends more credit to customers than competitors

Question 20

Below are selected ratios for Manufacturers Corporation. Use this information answer the
following questions. $$\begin{array}{l}
\text { 田 }\
\begin{array} { | l | l | r | r | r | } 
\hline & & \text { Year 1 } & \text { Year 2 } & \text { Year 3 } \
\hline 1 . & \text { Net operating asset turnover } & 1.4 & 1.31 & 1.25 \
\hline \text { 2. } & \text { Inventory turnover } & 5.6 & 5.0 & 4.6 \
\hline 3 . & \text { Accounts receivable turnover } & 12.1 & 11.9 & 12.1 \
\hline 4 . & \text { Fixed assets turnover } & 1.3 & 1.29 & 1.29 \
\hline 5 . & \text { Net operating profit margin } & 4.5 \% & 4.6 \% & 4.8 \% \
\hline \text { 6. } & \text { Net operating assets/equity } & 2.10 & 1.98 & 1.77 \
\hline \text { 7. } & \text { EBIT/revenues } & 8.9 \% & 8.6 \% & 8.6 \% \
\hline 8 . & \text { Gross margin } & 20.1 \% & 19.9 \% & 19.8 \% \
\hline \text { 9. } & \text { Income tax rate } & 35 \% & 35 \% & 35 \% \
\hline
\end{array}
\end{array}$$ 
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.

Accepted Answer

The answer of Below are selected ratios for Manufacturers Corporation....

Exam 8: Return on Invested Capital and Profitability Analysis

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

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.

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?

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.

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.

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