Chapter 4

Question 1

Define ROE

Answer 1

Relates net income to average total stockholders’ equity from the BS

Net income / Average stockholders’ equity

Question 2

What are the 2 methods for ROE disaggreation

Answer 2

1. The traditional DuPont analysis - disaggregates return equity in components of profitability, productivity, and leverage
2. Extends Duppont analysis by tanking an ROE analysis with an operating focus that separates operating and nonoperating activities. Operating activities are the drivers of shareholder value.

ROE = Net income / Average stockholders’ equity

=

(ROA) Net income / average total assets x
(FL)Average total assets / Average stockholders’ equity

FL = Financial Leverage

Question 3

What are Return on Assets

Answer 3

ROA measures return fromt eh perspective of the entire company. Includes both profitabliity (numberator) and total company assets (denominator)

Question 4

What is Financial Leverage

Answer 4

FL, the second component of ROE, measures the degree to which the company finances its assets with debt versus equity

In DuPont analysis, FL = Avg Total Assets / Avg stockholers’ equity

Question 5

Disaggregation of ROA

Answer 5

See image

The two drivers of ROA

1. Profit Margin (PM)
2. Asset Turnover (AT)

Question 6

Analysis of Profitability and Productivity

Answer 6

see image

Question 7

Review the Disaggregation of ROE and its margins

Answer 7

see image

Question 8

What is Profit Margin

Answer 8

Net Income / Sales

Question 9

What is Operating Expense Margin

Answer 9

SG&A

SG&A expanse / Sales

Question 10

Analysis of Working Capital Components (Turnover Ratios)

Answer 10

1. Accounts receivable turnover = Sales / Average accounts receivable
2. Inventory turnover = Cogs / Average inventories
3. Accounts payable turnover = Gogs / Average accounts payable

Question 11

Define the “Days” measures for working captial accounts

Answer 11

Days sales outstanding (DSO) 365 / Accounts rec. turnover

+ Days invenetory outstanding (DIO) 365 / Inventory turnover

• Days payables outstanding (DPO) 365 / Accts payable turnover

= Cash Conversion Cycle (CCC) DSO + DIO - DPO

Question 12

What does the CCC measure

Answer 12

The average time (in days) to sell inventories, collect the receivables from the sale, pay the payables incurred for the inventory purchase, and return to cash

Lower is better

Question 13

Define ROE

Answer 13

Return on Equity

ROE = Operating return + Nonoperating return

Question 14

Define RNOA

Answer 14

Return on Net Operating Assets

RNOA = Net operating profit after taxes (NOPAT)

Average net operating assets (NOA)

NOPAT / NOA

Question 15

Define Net Operating Assets

Answer 15

Net operating assets = Operating assets - Operating liabilities

To do this, you must partition the BS into Opetating Assets and Operating Liabilities

Operating Assets Operating Liabilities

Accounts receivable Accounts payable
Inventories Accrued expenses
Prepaid expenses and supplies Unearned or deferred revenue
PPE Income taxes payable
Intangible assets and Goodwill Deferred income tax liabilities
Deferred income tax assets Pensino and other post-employ
Equitey method investments obligatinos

Question 16

Define Net Nonoperating Obligations (NNO)

Answer 16

Assets and Liabilities that are not used as part fo the core business activities of the company

Nonoperating Liabilities Nonoperating Assets

Short and long term debt Cash adn cash equivalents
Lease obligations Marketable securities
Interest payable Discontinued assets
Dividends payable Derivative assets
Discontinued liabilities
Derivative liabilities

Question 17

Operating Line Items on the Income Statement (IS)

Answer 17

• Revenues
• Cogs
• SG&A (including wages, advertising, occupancy, insurance, depreciation and amoritization, liquidating, and restructuring
• R&D - often part of SG&A
• Impairments of operating asets such as goodwill
• Income from strategic investments
• Gains and losses on disposals of operating assets such as PPE and strategic investments
• “Other” op ex or income

Question 18

Nonoperating Line Items on the Income Statement

Answer 18

• interest expenses on debt and lease obligations
• Loss or income relating to discontinued operations
• Debt issuance and retirement costs
• Interest and dividend income on nonstrategic investments
• Gains or losses on the sale of nonstrategic investments
• “Other” income or expense if reported separately from operating income

Question 19

Define Tax on operating profit

Answer 19

= Tax expense + (Pretax net nonoperating expense x Statutory tax rate)

(Pretax net nonoperating expense x Statutory tax rate) = “Tax Shield”

Question 20

Define Net Nonoperating Expense (NNE)

Answer 20

NOPAT = Net income + NNE

Question 21

Define Net Operating Profit Margin

Answer 21

Reveals how much operating profit the company earns from each sales dollar. It’s affected by:

1. Gross profit (revenues - cogs)
2. Other operating expenses and all overhead costs that the cmopany incurs to support its operating activities

NOPS =

Net operating profit after tax / Sales

Question 22

Define Net Operating Asset Turnover

Answer 22

Measures the productivity of the company’s net operating assets. Higher NOAT is preferrable

NOAT =

Sales / Average net operating assets