Deck 8: Return on Invested Capital and Profitability Analysis

Question 1

$$\begin{array} { | l | r | r | } \hline & \underline { 2005 } & { \underline { \$ 004 } } \\\hline \text { Operating assets } & \$ 10,500 & \$ 10,000 \\\hline \text { Short-term debt } & 1,000 & 1,000 \\\hline \text { Long-term debt } & 3,500 & 3,000 \\\hline \text { Minority interest } & 500 & 450 \\\hline \text { Common equity } & 5,500 & 5,000 \\\\\hline \text { Operating income } & 1,350& \\\hline \text { Interest expense } & 350& \\\hline \text { Tax expense } ( 40 \% ) & 400 & \\\hline \text { Minority interest } & 50& \\\hline \text { Net income } & 550 & \\\hline\end{array}$$

-Return on common equity for 2005 is:

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

Answer 1

10.47%

Question 2

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

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) The change in the return on net operating assets is unclear, there is not sufficient information

Answer 2

D

Question 3

Which of the following would explain an observed decrease in return on equity, all else equal?

A) Decrease in tax rate
B) Increase in interest rate on debt
C) Stock split
D) Stock dividend

Answer 3

B

Question 4

When calculating return on net operating assets, interest expense net of tax is added back to net income for purposes of calculating the numerator. What tax rate should be used?

A) effective tax rate
B) marginal tax rate
C) statutory federal tax rate
D) statutory federal tax rate plus statutory state tax rate

Question 5

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

-Return on net operating assets for 2005 is:

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

Question 6

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:

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

Question 7

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

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 8

Eyster Corporation reported $10M in earnings and paid dividends of $3M for fiscal 2005.Return on equity and dividend payout are expected to remain constant for the foreseeable future. Net book value at the end of fiscal 2004 was 100M. Cost of equity is 10%. Using the residual income method, the intrinsic value of Eyster's stock at the end of 2005 should be:

A) $110M
B) $107M
C) $100M
D) not determinable

Question 9

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:

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

Question 10

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:

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 11

Which of the following is the best measure of operating efficiency?

A) Return on net operating assets
B) Return on equity
C) Return on sales
D) Return on inventory

Question 12

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

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 13

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. $$\begin{array} { | l | c | c | } \hline & \text { NOPAT Margin } & \begin{array} { c } \text { Net Operating Asset } \\\text { Turnover }\end{array} \\\hline \text { Industry A } & 8.0 \% & 1.5 \\\hline \text { Industry B } & 1.2 \% & 5.5 \\\hline \text { Industry C } & 5.4 \% & 1.0 \\\hline\end{array}$$ Match the industry to A, B or C $$\begin{array} { | l | c | c | c | } \hline & \text { Grocery Retail } & \text { Oil and Gas } & \text { Drug } \\\hline \text { A) } & \text { B } & \text { C } & \text { A } \\\hline \text { B) } & \text { B } & \text { A } & \text { C } \\\hline \text { C) } & \text { C } & \text { A } & \text { B } \\\hline \text { D) } & \text { C } & \text { B } & \text { A } \\\hline\end{array}$$

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

Question 14

Which of the following statements is correct concerning changes from year 1 to year 2 at Tricrop?

A) Despite favorable changes in the tax rate return on net operating assets has decreased
B) Despite favorable changes in net operating asset utilization return on net operating assets has decreased
C) Largely because of favorable changes in tax rates return on net operating assets has increased
D) Largely due to favorable changes in leverage return on net operating assets has increased

Question 15

Which of the following will increase the sustainable equity growth of a company, all other things equal?

A) Increase dividend payout
B) Pay suppliers more quickly
C) Pay suppliers more slowly
D) Decrease dividend payout

Question 16

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

-Return on equity for 2005 is:

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

Question 17

Which of the following statements is correct?

A) Net operating profit margin divided by net operating asset turnover equals return on net operating assets
B) Return on net operating assets can be disaggregated into net operating profit margin and leverage
C) Return on equity equals return on net operating assets less interest, net of tax
D) Return on equity can be disaggregated into net operating profit margin, net operating asset turnover and leverage

Question 18

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

A) Return on equity
B) Gross margin
C) Current ratio
D) Net operating asset turnover

Question 19

$$\begin{array} { | l | r | r | } \hline & \underline { 2005 } & { \underline { \$ 004 } } \\\hline \text { Operating assets } & \$ 10,500 & \$ 10,000 \\\hline \text { Short-term debt } & 1,000 & 1,000 \\\hline \text { Long-term debt } & 3,500 & 3,000 \\\hline \text { Minority interest } & 500 & 450 \\\hline \text { Common equity } & 5,500 & 5,000 \\\\\hline \text { Operating income } & 1,350& \\\hline \text { Interest expense } & 350& \\\hline \text { Tax expense } ( 40 \% ) & 400 & \\\hline \text { Minority interest } & 50& \\\hline \text { Net income } & 550 & \\\hline\end{array}$$

-Return on operating assets for 2005 is:

A) 7.9%
B) 7.41%
C) 8.78%
D) 8.1%

Question 20

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

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

Question 21

Purchases divided by accounts payable provides information about:

A) capital structure
B) management of working capital
C) gross profit margin
D) profitability

Question 22

Which of the following situations is most likely to explain an accounts receivable turnover that is lower than the industry norm?

A) The company makes less credit sales than industry
B) The company gives customers less time to pay than its competitors
C) The company has been selling inferior products to competitors
D) The company is systematically over-estimating bad debts

Question 23

Which of the following statements about the return on shareholders' investment (ROSI) is correct?

A) If book value of equity is less than market value, ROSI is greater than ROCE
B) ROSI will be higher the greater the dividend payout ratio
C) ROSI is likely to be more volatile than ROCE
D) ROSI normally equals ROCE

Question 24

If Yutter's dividend payout ratio increased to 50% after year 1 then:

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

Question 25

When considering the difference between return on net operating assets (RNOA) and return on common shareholders' equity (ROCE), which of the following statements is incorrect?

A) Preferred dividends are deducted from the numerator when calculating ROCE but not when calculating RNOA
B) RNOA is a pre-interest measure but ROCE is not
C) RNOA is a post-interest measure but ROCE is not
D) RNOA is independent of the form of financing, but ROCE is not.

Question 26

Which of the following statements about the equity growth rate is correct?
I) the higher the ROCE the higher equity growth rate, all other things equal
II) the higher the dividend payout the higher the equity growth rate
III) the equity growth rate is unaffected by the cost of debt
IV) the equity growth rate indicates the expected growth in stock price each period

A) I, II, III and IV
B) I, II and III
C) I and III
D) I only

Question 27

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

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 28

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 correct?

A) Widget has higher RNOA than Tools
B) Widget has lower RNOA than Tools
C) Widget has same RNOA as Tools
D) Insufficient information to calculate RNOA

Question 29

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 best explains the difference in observed net operating asset turnovers?

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

Question 30

Which of the following statements about the relationship between RNOA and ROCE is correct?

A) ROCE is always greater than RNOA
B) ROCE is greater than RNOA if RNOA is greater than after-tax cost of dividends
C) ROCE is greater than RNOA if RNOA is greater than cost of debt
D) ROCE is greater than RNOA if RNOA is greater than after-tax cost of debt

Question 31

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?

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

Question 32

Widget has a higher EBIT/Revenue but lower net operating profit margin than Tool. Which of the following statements could explain this? As a percentage of sales:

A) Widget has greater interest expense and taxes
B) Widget has greater interest expense but lower taxes
C) Widget has lower interest expense but higher taxes
D) Widget has lower interest expense and taxes

Question 33

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

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

Question 34

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 2, which of the following adjustments to the asset base is most appropriate to consider?

A) Accumulated depreciation adjustment
B) Intangible asset adjustment
C) Nonoperating asset adjustment
D) No asset adjustment

Question 35

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 could explain the difference in observed tax rates?

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 36

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?

A) Accumulated depreciation adjustment
B) Intangible asset adjustment
C) Nonoperating asset adjustment
D) No asset adjustment

Question 37

Cost of goods sold divided by inventory provides information about (choose one answer):

A) profitability
B) capital structure
C) management of working capital
D) gross profit margin

Question 38

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 3, which of the following adjustments to the asset base is most appropriate to consider?

A) Accumulated depreciation adjustment
B) Intangible asset adjustment
C) Nonoperating asset adjustment
D) No asset adjustment

Question 39

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 Yutter's sustainable equity growth rate?

A) 9.12%
B) 9.88%
C) 11.4%
D) 12.0%

Question 40

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?

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 41

There is only one way to measure invested capital.

Question 42

The relation between a company's return on common equity (ROCE) and return on net operating assets (RNOA) reveals information about the company's success with financial leverage.

Question 43

When calculating return on net operating assets it may be necessary to adjust assets to reflect the fact that not all assets are operating assets.

Question 44

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.

Question 45

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

Question 46

Return on invested capital is a better measure of profitability than earnings as earnings numbers fail to reflect the capital needed to generate those earnings.

Question 47

Sustainable equity growth rate is a function of return on common stockholders' equity and the dividend payout ratio.

Question 48

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.

Question 49

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

Question 50

An analysis of a company's performance requires joint analysis of net income in relation to the invested capital.

Question 51

If a company has rapidly growing earnings per share, their return on net operating assets must be increasing too.

Question 52

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

Question 53

Return on equity can be expressed as return on net operating assets multiplied by leverage (net operating assets/equity) and by earnings leverage.

Question 54

When calculating return on equity minority interest is added to the numerator as it has been deducted in arriving at net income.

Question 55

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

Question 56

It is possible to have an increasing return on net operating assets while net operating profit margin is decreasing.

Question 57

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.

Question 58

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.

Question 59

The two components of RNOA, net operating profit margin and NOA turnover, are independent of each other.

Question 60

Return on equity is the return stockholders have received during the past year.

Question 61

When calculating return on net operating assets, the numerator is net income plus minority interest.

Question 62

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.

Question 63

Below are selected ratios for Widget Corporation and Tools Inc. Use this information answer the following questions.
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).

Question 64

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

Question 65

The accounting-based stock valuation formula calculates the value of a stock as the book value of the net operating assets plus the present value of future expected dividends discounted at the cost of equity.

Question 66

You are given the following data for Good Company Inc. for 2004, 2005, and 2006 (amounts
in thousands).
a. Calculate ROCE for the three years.
b. Calculate basic EPS for the three years.
c. Interpret your findings for both ROCE and EPS.

Question 67

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

Question 68

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.

Question 69

Indicate the effect of the following transactions on:
i.Return on net operating Assets (RNOA)
ii. Return on common stockholders equity (ROCE)
iii. Earnings per share (basic)
Consider each transaction independently and explain your answer. Assume that ROCE is higher than RNOA.
Company issues more preferred stock and uses proceeds to reduce accounts payable
Company has a stock split
Company converts to just-in-time inventory system (JIT). This allows them to hold half the levels of inventory for the same amount of sales (sales themselves are not increased by this change to JIT).

Question 70

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.

Question 71

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.

Question 72

Below are selected ratios for Manufacturers Corporation. Use this information answer the
following questions.
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.

Question 73

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.
Essay Questions

Question 74

An advantage of leverage that benefits common stockholders is successful trading on the equity.

Question 75

When calculating return on net operating assets analysts sometimes make adjustments to the net operating asset base used in the denominator or the ratio. Three possible adjustments are listed below. Explain what these adjustments are, and discuss the merits of these adjustments.
Nonoperating asset adjustment.
Intangible asset adjustment.
Accumulated depreciation adjustment

Question 76

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