1、Ch叩ter8ReturnonInvestedCapitalandProfitabilityAnalysisREVIEWReturnoninvestedcapitalisimportantinouranalysisoffinancialstatements.Financialstatementanalysisinvolvesourassessingbothriskandreturn.Thepriorthreechaptersfocusedprimarilyonrisk,whereasthischapterextendsouranalysistoreturn.Returnoninvestedca
2、pitalreferstoacompanysearningsrelativetoboththelevelandsourceoffinancing.Itisameasureofacompanyssuccessinusingfinancingtogenerateprofits,andisanexcellentmeasureofoperatingperformance.Thischapterdescribesreturnoninvestedcapitalanditsrelevancetofinancialstatementanalysis.Wealsoexplainvariationsinmeasu
3、rementofreturnoninvestedcapitalandtheirinterpretation.Wealsodisaggregatereturnoninvestedcapitalintoimportantcomponentsforadditionalinsightsintocompanyperformance.Theroleoffinancialleverageanditsimportanceforreturnsanalysisisexamined.Thischapterdemonstrateseachoftheseanalysistechniquesusingfinancials
4、tatementdata.OUTLINE ImportanceofReturnonInvestedCapitalMeasuringManagerialEffectivenessMeasuringProfitabilityMeasuringforPlanningandControl ComponentsofReturnonInvestedCapitalDefiningInvestedCapitalAdjustmentstoInvestedCapitalandIncomeComputingReturnonInvestedCapital AnalyzingReturnonNetOperatingAs
5、setsDisaggregatingReturnonNetOperatingAssetsRelationbetweenProfitMarginandAssetTurnoverProfitMarginAnalysisAssetTurnoverAnalysis AnalyzingReturnonCommonEquityDisaggregatingReturnonCommonEquityFinancialLeverageandReturnonCommonEquityAssessingGrowthinCommonEquityANALYSISOBJECTIVES Describetheusefulnes
6、sofreturnmeasuresinfinancialstatementanalysis. Explainreturnoninvestedcapitalandvariationsinitscomputation. Analyzereturnonnetoperatingassetsanditsrelevanceinouranalysis. Describedisaggregationofreturnonnetoperatingassetsandtheimportanceofitscomponents. Describetherelationbetweenprofitmarginandturno
7、ver. Analyzereturnoncommonshareholdersequityanditsroleinouranalysis. Describedisaggregationofreturnoncommonshareholdersequityandtherelevanceofitscomponents. Explainfinancialleverageandhowtoassessacompanyssuccessintradingontheequityacrossfinancingsources.QUESTIONS1. Thereturnthatisachievedinanyoneper
8、iodontheinvestedcapitalofacompanyconsistsofthereturns(andlosses)realizedbyitsvarioussegmentsanddivisions.Inturn,thesereturnsaremadeupoftheresultsachievedbyindividualproductlinesandprojects.Awell-managedcompanyexercisesrigorouscontroloverthereturnsachievedbyeachofitsprofitcenters,anditrewardsthemanag
9、ersonthebasisofsuchresults.Specifically,whenevaluatingnewinvestmentsinassetsorprojects,managementwillcomputetheestimatedreturnsitexpectstoachieveandusetheseestimatesasabasisforitsdecisiontoinvestornot.2. Profitgenerationisthefirstandforemostpurposeofacompany.Theeffectivenessofoperatingperformancedet
10、erminestheabilityofthecompanytosurvivefinancially,toattractsuppliersoffunds,andtorewardthemadequately.Returnoninvestedcapitalistheprimemeasureofcompanyperformance.Theanalystusesitasanindicatorofmanagerialeffectiveness,and/orameasureofthecompanysabilitytoearnasatisfactoryreturnoninvestment.3. Ifthein
11、vestmentbaseisdefinedascomprisingnetoperatingassets,thennetoperatingprofit(e.g.,beforeinterest)aftertax(NOPAT)istherelevantincomefiguretouse.Theexclusionofinterestfromincomedeductionsisduetoitsbeingregardedasapaymentfortheuseofmoneyfromthesuppliersofdebtcapital(inthesamewaythatdividendsareregardedas
12、apaymenttosuppliersofequitycapital).NOPATistheappropriateamounttomeasureagainstnetoperatingassetsasbothareconsideredtobeoperating.4. First,themotivationforexcludingnonproductiveassetsfrominvestedcapitalisbasedontheideathatmanagementisnotresponsibleforearningareturnonnon-operatinginvestedcapital.Seco
13、nd,theexclusionofintangibleassetsfromtheinvestmentbaseisoftenduetoskepticismregardingtheirvalueortheircontributiontotheearningpowerofthecompany.UnderGAAP,intangiblesarecarriedatcost.However,iftheircostexceedstheirfutureutility,theyarewrittendown(ortherewillbeanuncertaintyexceptionregardingtheircarry
14、ingvalueintheauditorsopinion).Theexclusionofintangibleassetsfromtheassetbasemustbebasedonmoresubstantialevidencethanamerelackofunderstandingofwhattheseassetsrepresentoranunsupportedsuspicionregardingtheirvalue.Thisimpliesthatintangibleassetsshouldgenerallynotbeexcludedfrominvestedcapital.5. Thebasic
15、formulaforcomputingthereturnoninvestmentisnetincomedividedbytotalinvestedcapital.Wheneverwemodifythedefinitionoftheinvestmentbaseby,say,omittingcertainitems(liabilities,idleassets,intangibles,etc.)wemustalsoadjustthecorrespondingincomefiguretomakeitconsistentwiththemodifiedassetbase.6. Therelationof
16、netincometosalesisameasureofoperatingperformance(profitmargin).Therelationofsalestototalassetsisameasureofassetutilizationorturnover-ameansofdetermininghoweffectively(intermsofsalesgeneration)theassetsareutilized.Bothofthesemeasures,profitmarginaswellasassetutilization,determinethereturnrealizedonag
17、iveninvestmentbase.Salesareanimportantfactorinbothoftheseperformancemeasures.7. Profitmargin,althoughimportant,isonlyoneaspectofthereturnoninvestedcapital.Theotherisassetturnover.Consequently,whileCompanyBsprofitmarginishigh,itsassetturnovermayhavebeensufficientlydepressedsoastodragdowntheoverallret
18、urnoninvestedcapital,leadingtotheshareholderscomplaint.8. TheassetturnoverofCompanyXis3.TheprofitmarginofCompanyYis0.5%.Sincebothcompaniesareinthesameindustry,itisclearthatCompanyXmustconcentrateonimprovingitsassetturnover.Ontheotherhand,CompanyYmustconcentrateonimprovingitsprofitmargin.Morespecific
19、strategiesdependontheproductandindustry.9. Thesalestototalassets(assetturnover)componentofthereturnoninvestedcapitalmeasurereflectstheoverallrateofassetutilization.Itdoesnotreflecttherateofutilizationofindividualassetcategoriesthatenterintotheoverallassetturnover.Tobetterevaluatethereasonsfortheleve
20、lofassetturnoverorthereasonsforchangesinthatlevel,itishelpfultocomputetherateofindividualassetturnoversthatmakeuptheoverallturnoverrate.10. Theevaluationofreturnoninvestedcapitalinvolvesmanyfactors.Theinclusion/exclusionofextraordinarygainsandlosses,theuse/nonuseoftrends,theeffectofacquisitionsaccou
21、ntedforaspoolingsandtheirchanceofrecurrence,theeffectofdiscontinuedoperations,andthepossibilityofaveragingnetincomearejustafewofmanysuchfactors.Moreover,theanalystmusttakeintoaccounttheeffectsofprice-levelchangesonreturncalculations.Italsoisimportantthattheanalystbearinmindthatreturnoninvestedcapita
22、lismostcommonlybasedonbookvaluesfromfinancialstatementsratherthanonmarketvalues.Andfinally,manyassetseitherdonotappearinthefinancialstatementsoraresignificantlyunderstated.Examplesofsuchassetsareintangiblessuchaspatents,trademarks,researchanddevelopmentactivities,advertisingandtraining,andintellectu
23、alcapital.11. Theequitygrowthrateiscalculatedasfollows:Netincome-Preferreddividends-Commondividendpayout/Averagecommonequity.Thisisthegrowthrateduetotheretentionofearningsandassumesaconstantdividendpayoutovertime-Itindicatesthepossibilitiesofearningsgrowthwithoutresorttoexternalfinancing.Theresultin
24、gincreaseinequitycanbeexpectedtoearntherateofreturnthatthecompanyearnsonitsassetsand,thus,furthercontributetogrowthinearnings.12. a.Thereturnonnetoperatingassetsandthereturnoncommonstockholdersequitydifferbythecapitalinvestmentbase(anditscorrespondingeffectsonnetincome).RNOAreflectsthereturnonthenet
25、operatingassetsofthecompanywhereasROCEreflectstheperspectiveofcommonshareholders.b.ROCEcanbedisaggregatedintothefollowingcomponentstofacilitateanalysis:ROCE=RNOA+LeveragexSpread.RNOAmeasuresthereturnonnetoperatingassets,ameasureofoperatingperformance.Thesecondcomponent(LeveragexSpread)measurestheeff
26、ectsoffinancialleverage.ROCEisincreasedbyaddingfinancialleveragesolongasRNOAweightedaveragecostofcapital.Thatis,ifthefirmcanearnareturnonoperatingassetsthatisgreaterthanthecostofthecapitalusedtofinancethepurchaseofthoseassets,thenshareholdersarebetteroffaddingdebttoincreaseoperatingassets.13. a.ROCE
27、canbedisaggregatedasfollows:Netincome-PreferreddividendsSalesXSalesAveragecommonequityThisshowsthatuequityturnover”(salestoaveragecommonequity)isoneofthetwocomponentsofthereturnoncommonshareholdersequity.Assumingastableprofitmargin,theequityturnovercanbeusedtodeterminethelevelandtrendofROCE.Specific
28、ally,anincreaseinequityturnoverwillproduceanincreaseinROCEiftheprofitmarginisstableordeclineslessthantheincreaseinequityturnover.Forexample,acommonobjectiveofdiscountstoresistolowerpricesbyloweringprofitmargins,buttooffsetthisbyincreasingequityturnoverbymorethanthedecreaseinprofitmargin.b.Equityturn
29、overcanberewrittenasfollows:SaleSNetOperatingassetsNetoperatingassetsAveragecommonequityThefirstfactorreflectshowwellnetoperatingassetsarebeingutilized.Iftheratioisincreasing,thiscansignaleitheratechnologicaladvantageorunder-capacityandtheneedforexpansion.Thesecondfactorreflectstheuseofleverage.Leve
30、ragewillbehigherforthosefirmsthathavefinancedmoreoftheirassetsthroughdebt.Byconsideringthesefactorsthatcompriseequityturnover,itisapparentthatEPScannotgrowindefinitelyfromanincreaseinthesefactors.Thisisbecausethesefactorscannotgrowindefinitely.Evenifthereisatechnologicaladvantageinproduction,thesale
31、stonetoperatingassetsratiocannotincreaseindefinitely.Thisisbecausesoonerorlaterthefirmmustexpanditsnetoperatingassetbasetomeetrisingsalesorelsenotmeetsalesandloseashareofthemarket.Also,financingnewassetswithdebtcanincreasethenetoperatingassetstocommonequityratio.However,thiscanonlybepursuedtoapointa
32、twhichtimetheequitybasemustexpand(whichdecreasestheratio).14. Whenconvertibledebtsellsatasubstantialpremiumaboveparandisclearlyheldbyinvestorsforitsconversionfeature,thereisjustificationfortreatingitastheequivalentofequitycapital.Thisisparticularlytruewhenthecompanycanchooseatanytimetoforceconversio
33、nofthedebtbycallingitin.EXERCISESExercise8-1(35minutes)a. Firstalternative:NOPAT=$6,000,000*10%=$600,000Netincome=$600,000-$1,000,000*12%(1-.40)=$528,000Secondalternative:NOPAT=$6,000,000*10%=$600,000Netincome=$600,000-$2,000,000*12%(1-.40)=$456,000b. Firstalternative:ROCE=$528,000/$5,000,000=10.56%
34、Secondalternative:ROCE=$456,000/$4,000,000=11.40%c. Firstalternative:Assets-to-Equity=$6,000,000/$5,000,000=L2Secondalternative:Assets-to-Equity=$6,000,000/$4,000,000=li5d. First,Iefscomputereturnonassets(RNOA):Firstalternative:$600,000/$6,000,000三10%Secondalternative:$600,000/$6,000,000=10%Second,n
35、oticethattheinterestrateis12%onthedebt(bonds).Moreimportantly,theafter-taxinterestrateis7.2%(12%x(1-0.40)jwhichislessthanRNOA.Hence,thecompanyearnsmoreonitsassetsthanitpaysfordebtonanafter-taxbasis.Thatis,itcansuccessfullytradeontheequityusebondholdersfundstoearnadditionalprofits.Finally,sincethesec
36、ondalternativeusesmoredebt,asreflectedintheassets-to-equityratioinc,thesecondalternativeisprobablypreferred.Theshareholderswouldtakeonadditionalriskwiththesecondalternative,buttheexpectedreturnsaregreaterasevidencedfromcomputationsinb.a. NOPAT=Netincome=$10,000,000x10%=$1,000.000b. Firstalternative:
37、NOPAT=$1,000,000+$6,000,000*10%=$1,600,000Netincome=$1,600,000-($2,000,0005%x1-.40)=$1,540,000Secondalternative:NOPAT=$1,000,000+$6,000,000*10%=$1,600,000Netincome=$1,600,000-($6,000,0006%x1-.40)=$1,384,000c. Firstalternative:ROCE=$1,540,000/($10,000,000+$4,000,000)=11%Secondalternative:ROCE=$1,384,
38、000/($10,000,000+$0)=13.84%d. ROCEishigherunderthesecondalternativeduetosuccessfuluseofleveragethatis,successfullytradingontheequity.Note:Asset-to-Equityis1.14=$16mil./$14mil.(1.60=$16mil./$10mil.)underthefirst(second)alternative.Thecompanyshouldpursuethesecondalternativeintheinterestofshareholders(
39、assumingprojectedreturnsareconsistentwithcurrentperformancelevels).a. RNOA=2x5%=10%b. ROCE=10%+1.786x4.4%=17.86%C.RNOA10.00%Leverageadvantage7.86%Returnonequity17.86%Exercise8-4(30minutes)a.ComputationandInterpretationofROCE:Year9Year5Pre-taxprofitmarginAssetturnoverAssets-to-equityAfter-taxincomere
40、tention*ROCE(productofabove)9.07%0.1120.1090.460.443.253.400.5700.5569.54%*1-Taxrate.ROCEdeclinesfromYear5toYear9because:(1)pre-taxmargindecreasesbyapproximately3%,(2)assetturnoverdeclinesbyroughly4.3%,and(3)thetaxrateincreasesbyabout3.8%.ThecombinationofthesefactorsdrivesthedeclineinROCE-thisisdesp
41、itetheslightimprovementintheassets-to-equityratio.b.ThemainreasonEPSincreasesisthatshareholdershadalargeamountofassetsandequityworkingforthem.Namely,thecompanygrewwhilereturnonassetsandreturnonequityremainedfairlystable.Inaddition,theamountofpreferredstockdeclined,asdidtheamountofpreferreddividends.
42、Withthisdeclineinthecostofcarryingpreferredstock,earningsavailabletocommonstockincreased.(CFAAdapted)a. RNOA=3x7%=21%b. ROCE=RNOA+LEVxSpread=21%+(1.667x8.4%)=35%c. NetleverageadvantagetocommonequityReturnonnetoperatingassets21%Leverageadvantage14%Returnoncommonequity(roundingdifference).35%Exercise8
43、6(30minutes)a. Atthepresentlevelofdebt,ROCE=$157,500/$1,125,000=14%,Intheabsenceofleverage,thenoncurrentliabilitieswouldbesubstitutedwithequity.Accordingly,therewouldbenointerestexpensewithall-equityfinancing.Consequently,inthiscase,netincomewouldbeasfollows:Netincome(withleverage)$157,500Plusinter
44、estsaved($675,0008%)$54,000Lesstaxeffectofinterestexpense27,00027,000Netincome(withoutleverage)$184,500ROCEwithoutleverage=$184,500/$1,800,000=10.25%.ThismeansthatleverageisbeneficialtoRose,sshareholderssinceROCEis14%withleveragebutonly10.25%withoutleverage.b. NOPAT=$157,500+$675,000x8%x(1-.50)=$184
45、500RNOA=$184,500/($2,000,000-$200,000)=10.25%c. Thecompanyisutilizingborrowedfundsinitscapitalstructure.SincetheROCEisgreaterthanRNOA,theuseoffinancialleverageisbeneficialtostockholders.Specifically,theaftercostofdebtis4%andthefinancialleverage(NFO/Equity)is$675,000/$1,125,000=60%.Therefore,ROCE=RN
46、OA+LEVxSpread=10.25%+0.60x(10.25%-4%)=14%,asbefore.Thefavorableeffectoffinancialleverageisgivenbytheterm0.60x(10.25%-4%)=3.75%.1. C2. a3. cExercise8-8(20minutes)(Assessmentsofprofitmarginandassetturnoverarerelativetoindustrynorms.)a.Higherprofitmarginandlowerassetturnover.b. Higherassetturnoverandlo
47、werprofitmargin.c. Higherprofitmarginandsimilar/lowerassetturnover.d. Higherassetturnoverandsimilar/lowerprofitmargin.e. HigherassetturnoverandIowerZsimiIarprofitmargin.f. Higherassetturnoverandsimilar/higherprofitmargin.g. Higherassetturnoverandlowerprofitmargin.Exercise8-9(20minutes)Thememorandumt
48、oReliableAutoSalesPresidentwouldincludethefollowingpoints: BothReliableandLegendAutoSalesareperpetuallyinvesting$100,000inautomobileinventory. LegendAutoSalesisabletogeneratemoreprofitthanReliablebecauseitisturningoveritsinventory(10cars)moreoften.Specifically,Legendisturningitsinventoryover10timesperyearwhileReliableisturningitsinventoryoveronly5timesperyear.Hence,giventhesameinvestmentinautomobileinventory,LegendistwiceasprofitableasReliable. EncourageReliabletosacrificesomereturnoneachsaletoincreasetheinventoryturnover.Byslightlyreducingprice,relat
