财务报表分析英文版答案.doc

财务报表分析英文版答案.doc

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Chapter08-ReturnOnInvestedCapitalandProfitabilityAnalysis

Chapter8

ReturnOnInvestedCapitalAndProfitabilityAnalysis

REVIEW

Returnoninvestedcapitalisimportantinouranalysisoffinancialstatements.Financialstatementanalysisinvolvesourassessingbothriskandreturn.Thepriorthreechaptersfocusedprimarilyonrisk,whereasthischapterextendsouranalysistoreturn.Returnoninvestedcapitalreferstoacompany'searningsrelativetoboththelevelandsourceoffinancing.Itisameasureofacompany'ssuccessinusingfinancingtogenerateprofits,andisanexcellentmeasureofoperatingperformance.Thischapterdescribesreturnoninvestedcapitalanditsrelevancetofinancialstatementanalysis.Wealsoexplainvariationsinmeasurementofreturnoninvestedcapitalandtheirinterpretation.Wealsodisaggregatereturnoninvestedcapitalintoimportantcomponentsforadditionalinsightsintocompanyperformance.Theroleoffinancialleverageanditsimportanceforreturnsanalysisisexamined.Thischapterdemonstrateseachoftheseanalysistechniquesusingfinancialstatementdata.

OUTLINE

·ImportanceofReturnonInvestedCapital

MeasuringManagerialEffectiveness

MeasuringProfitability

MeasuringforPlanningandControl

·ComponentsofReturnonInvestedCapital

DefiningInvestedCapital

AdjustmentstoInvestedCapitalandIncome

ComputingReturnonInvestedCapital

·AnalyzingReturnonNetOperatingAssets

DisaggregatingReturnonNetOperatingAssets

RelationbetweenProfitMarginandAssetTurnover

ProfitMarginAnalysis

AssetTurnoverAnalysis

·AnalyzingReturnonCommonEquity

DisaggregatingReturnonCommonEquity

FinancialLeverageandReturnonCommonEquity

AssessingGrowthinCommonEquity

ANALYSISOBJECTIVES

·Describetheusefulnessofreturnmeasuresinfinancialstatementanalysis.

·Explainreturnoninvestedcapitalandvariationsinitscomputation.

·Analyzereturnonnetoperatingassetsanditsrelevanceinouranalysis.

·Describedisaggregationofreturnonnetoperatingassetsandtheimportanceofitscomponents.

·Describetherelationbetweenprofitmarginandturnover.

·Analyzereturnoncommonshareholders'equityanditsroleinouranalysis.

·Describedisaggregationofreturnoncommonshareholders'equityandtherelevanceofitscomponents.

·Explainfinancialleverageandhowtoassessacompany'ssuccessintradingontheequityacrossfinancingsources.

QUESTIONS

1.Thereturnthatisachievedinanyoneperiodontheinvestedcapitalofacompanyconsistsofthereturns（andlosses）realizedbyitsvarioussegmentsanddivisions.Inturn,thesereturnsaremadeupoftheresultsachievedbyindividualproductlinesandprojects.Awellmanagedcompanyexercisesrigorouscontroloverthereturnsachievedbyeachofitsprofitcenters,anditrewardsthemanagersonthebasisofsuchresults.Specifically,whenevaluatingnewinvestmentsinassetsorprojects,managementwillcomputetheestimatedreturnsitexpectstoachieveandusetheseestimatesasabasisforitsdecisiontoinvestornot.

2.Profitgenerationisthefirstandforemostpurposeofacompany.Theeffectivenessofoperatingperformancedeterminestheabilityofthecompanytosurvivefinancially,toattractsuppliersoffunds,andtorewardthemadequately.Returnoninvestedcapitalistheprimemeasureofcompanyperformance.Theanalystusesitasanindicatorofmanagerialeffectiveness,and/orameasureofthecompany'sabilitytoearnasatisfactoryreturnoninvestment.

3.Iftheinvestmentbaseisdefinedascomprisingnetoperatingassets,thennetoperatingprofit（e.g.,beforeinterest）aftertax（NOPAT）istherelevantincomefiguretouse.Theexclusionofinterestfromincomedeductionsisduetoitsbeingregardedasapaymentfortheuseofmoneyfromthesuppliersofdebtcapital（inthesamewaythatdividendsareregardedasapaymenttosuppliersofequitycapital）.NOPATistheappropriateamounttomeasureagainstnetoperatingassetsasbothareconsideredtobeoperating.

4.First,themotivationforexcludingnonproductiveassetsfrominvestedcapitalisbasedontheideathatmanagementisnotresponsibleforearningareturnonnon-operatinginvestedcapital.Second,theexclusionofintangibleassetsfromtheinvestmentbaseisoftenduetoskepticismregardingtheirvalueortheircontributiontotheearningpowerofthecompany.UnderGAAP,intangiblesarecarriedatcost.However,iftheircostexceedstheirfutureutility,theyarewrittendown（ortherewillbeanuncertaintyexceptionregardingtheircarryingvalueintheauditor'sopinion）.Theexclusionofintangibleassetsfromtheassetbasemustbebasedonmoresubstantialevidencethanamerelackofunderstandingofwhattheseassetsrepresentoranunsupportedsuspicionregardingtheirvalue.Thisimpliesthatintangibleassetsshouldgenerallynotbeexcludedfrominvestedcapital.

5. Thebasicformulaforcomputingthereturnoninvestmentisnetincomedividedbytotalinvestedcapital.Wheneverwemodifythedefinitionoftheinvestmentbaseby,say,omittingcertainitems（liabilities,idleassets,intangibles,etc.）wemustalsoadjustthecorrespondingincomefiguretomakeitconsistentwiththemodifiedassetbase.

6. Therelationofnetincometosalesisameasureofoperatingperformance（profitmargin）.Therelationofsalestototalassetsisameasureofassetutilizationorturnover—ameansofdetermininghoweffectively（intermsofsalesgeneration）theassetsareutilized.Bothofthesemeasures,profitmarginaswellasassetutilization,determinethereturnrealizedonagiveninvestmentbase.Salesareanimportantfactorinbothoftheseperformancemeasures.

7. Profitmargin,althoughimportant,isonlyoneaspectofthereturnoninvestedcapital.Theotherisassetturnover.Consequently,whileCompanyB'sprofitmarginishigh,itsassetturnovermayhavebeensufficientlydepressedsoastodragdowntheoverallreturnoninvestedcapital,leadingtotheshareholder'scomplaint.

8. TheassetturnoverofCompanyXis3.TheprofitmarginofCompanyYis0.5%.Sincebothcompaniesareinthesameindustry,itisclearthatCompanyXmustconcentrateonimprovingitsassetturnover.Ontheotherhand,CompanyYmustconcentrateonimprovingitsprofitmargin.Morespecificstrategiesdependontheproductandindustry.

9. Thesalestototalassets（assetturnover）componentofthereturnoninvestedcapitalmeasurereflectstheoverallrateofassetutilization.Itdoesnotreflecttherateofutilizationofindividualassetcategoriesthatenterintotheoverallassetturnover.Tobetterevaluatethereasonsforthelevelofassetturnoverorthereasonsforchangesinthatlevel,itishelpfultocomputetherateofindividualassetturnoversthatmakeuptheoverallturnoverrate.

10. Theevaluationofreturnoninvestedcapitalinvolvesmanyfactors.Theinclusion/exclusionofextraordinarygainsandlosses,theuse/nonuseoftrends,theeffectofacquisitionsaccountedforaspoolingsandtheirchanceofrecurrence,theeffectofdiscontinuedoperations,andthepossibilityofaveragingnetincomearejustafewofmanysuchfactors.Moreover,theanalystmusttakeintoaccounttheeffectsofprice-levelchangesonreturncalculations.Italsoisimportantthattheanalystbearinmindthatreturnoninvestedcapitalismostcommonlybasedonbookvaluesfromfinancialstatementsratherthanonmarketvalues.Andfinally,manyassetseitherdonotappearinthefinancialstatementsoraresignificantlyunderstated.Examplesofsuchassetsareintangiblessuchaspatents,trademarks,researchanddevelopmentactivities,advertisingandtraining,andintellectualcapital.

11. Theequitygrowthrateiscalculatedasfollows:

[Netincome–Preferreddividends–Commondividendpayout]/Averagecommonequity.

Thisisthegrowthrateduetotheretentionofearningsandassumesaconstantdividendpayoutovertime.Itindicatesthepossibilitiesofearningsgrowthwithoutresorttoexternalfinancing.Theresultingincreaseinequitycanbeexpectedtoearntherateofreturnthatthecompanyearnsonitsassetsand,thus,furthercontributetogrowthinearnings.

12. a. Thereturnonnetoperatingassetsandthereturnoncommonstockholders'equitydifferbythecapitalinvestmentbase（anditscorrespondingeffectsonnetincome）.RNOAreflectsthereturnonthenetoperatingassetsofthecompanywhereasROCEreflectstheperspectiveofcommonshareholders.

b. ROCEcanbedisaggregatedintothefollowingcomponentstofacilitateanalysis:

ROCE=RNOA+LeveragexSpread.RNOAmeasuresthereturnonnetoperatingassets,ameasureofoperatingperformance.Thesecondcomponent（LeveragexSpread）measurestheeffectsoffinancialleverage.ROCEisincreasedbyaddingfinancialleveragesolongasRNOA>weightedaveragecostofcapital.Thatis,ifthefirmcanearnareturnonoperatingassetsthatisgreaterthanthecostofthecapitalusedtofinancethepurchaseofthoseassets,thenshareholdersarebetteroffaddingdebttoincreaseoperatingassets.

13. a. ROCEcanbedisaggregatedasfollows:

Thisshowsthat“equityturnover”（salestoaveragecommonequity）isoneofthetwocomponentsofthereturnoncommonshareholders'equity.Assumingastableprofitmargin,theequityturnovercanbeusedtodeterminethelevelandtrendofROCE.Specifically,anincreaseinequityturnoverwillproduceanincreaseinROCEiftheprofitmarginisstableordeclineslessthantheincreaseinequityturnover.Forexample,acommonobjectiveofdiscountstoresistolowerpricesbyloweringprofitmargins,buttooffset