Asset Effectiveness & Efficiency Flashcards
Return on Investment (ROI) %
vs
Residual Income (RI) $ Amount
Return On Investment= Income/Investment Capital
Return on Investment =(Rev-COGS-G&A exp)/Inv Capital
= %
Residual Income = Income - (Investment x Hurdle Rate)
= $ amount
Return on Assets (ROA)
= Net Income
_______________
Avg. Total Assets
Return on Assets and ROI problems …………..
has a short-term focus. Investment Myopia - focuses managers on maximizing short-term returns.
Disincentive to invest in additional productive resources because their short term results will be to reduce ROI.
ROI Flowchart
Profit Margin x Investment Turnover = ROI
Income/Sales x Sales/Invested Capital
after eliminations formula ends up:
Income/Invested Capital
Operating Income/Avg. Operating Assets
ROA Formula
Net Income
ROA = _______________
Avg. Total Assets
ROE (Return on Equity) focus is on return to ALL investors
Net Income
ROE = __________________
Total Equity
Advantage - IT IS SIMPLE TO COMPUTE
Disadvantage - Need to see components to see WHY??
Dupont Analysis - A more detailed computation of ROE
Has THREE (3) Components:
- Net Profit margin
- Asset Turnover
- Financial Leverage
NPM x AT x FL
Net Inc/Sales x Sales/Avg Tot Ass. x Avg Tot Ass/Equity
Residual Income
Measures the “Excess” of actual income earned by an investment OVER the return required/hurdle rate.
Res. Inc. = Net Income - Required Return (in dollars)
the Required Return = NBV (equity) x Hurdle Rate
he imputed interest rate used in the residual income approach for performance measurement and evaluation can best be characterized as the
Historical weighted average cost of capital is usually used as the target or hurdle rate in the residual income approach.
Economic Value Added (EVA)
Economic value-added is a residual income technique used for capital budgeting and performance evaluation. It represents the residual (excess) income of project earnings in excess of the cost of capital (including cost of equity) associated with invested capital.
Times Interest Earned Ratio
= the number of times the interest charges are covered by net operating income BEFORE interest & taxes (EBIT)
Investment Turnover Rate
Sales / Avg Assets
