Ratio Analysis

Question 1

What does ROE stand for, and what does it measure?

Answer 1

Return on Equity, it measures the profit earned for each euro of common equity.

Question 2

What is the formula for ROE in the advanced DuPont model?

Answer 2

ROE = RNOA + Spread * (NFO / Equity)

Question 3

Define RNOA.

Answer 3

Return on Net Operating Assets, calculated as Net Operating Income / Net Operating Assets

Question 4

What is NOI?

Answer 4

Net Operating Income = Operating Income * (1 - Tax)

Question 5

What is NOA?

Answer 5

Net Operating Assets = Operating Assets - Operating Liabilities

Question 6

What is NFO?

Answer 6

Net Financial Obligations = Debt + Preferred + Minority - Financial Assets

Question 7

What is the Spread in the DuPont Model?

Answer 7

Spread = RNOA - After-Tax Cost of Debt

Question 8

How does leverage affect ROE in the advanced DuPont model?

Answer 8

Leverage increases ROE when spread is positive, and decreases it when spread is negative.

Question 9

How is cost of debt adjusted in the spread calculation?

Answer 9

It’s adjusted by multiplying the interest rate by (1 - tax rate)

Question 10

What does a negative spread imply?

Answer 10

The firm is borrowing at a higher rate than it earns = debt destroys value.

Question 11

Why is RNOA a better measure of operating performance than ROE?

Answer 11

RNOA strips out financing effects, focusing only on core operations.

Question 12

What does high RNOA with low ROE usually indicate?

Answer 12

The firm is under-leveraged or has negative spread.

Question 13

What are the two components of RNOA?

Answer 13

NOI Margin and NOA Turnover

Question 14

What does NOI margin tell you?

Answer 14

How much profit the firm makes per euro of sales - a measure of pricing power or cost control.

Question 15

What does NOA turnover measure?

Answer 15

How efficiently the company uses its operating assets to generate revenue.

Question 16

What’s the margin-turnover tradeoff?

Answer 16

Firms with high margins tend to have low turnover, and vice versa - depending on business strategy.

Question 17

Why is high ROE not always good?

Answer 17

It could come from excessive debt or one-off gains, not real business strength.

Question 18

What type of company would have high turnover and low margins?

Answer 18

A cost leader like Walmart or Ryanair.

Question 19

What type of company would have low turnover and high margins?

Answer 19

A luxury or niche brand like Ferrari or Rolex.

Question 20

Can a firm have a high RNOA and low ROE?

Answer 20

Yes, if it has no leverage or a negative spread.

Question 21

Why is equity averaged in ROE calculation?

Answer 21

To reflect the average amount of capital invested over the period.

Question 22

What happens to ROE if a company increases debt without improving RNOA?

Answer 22

ROE may rise temporarily but at higher risk; if spread turns negative, ROE will drop.

Question 23

Why is NFO net of financial assets?

Answer 23

Because excess financial assets reduce the firm’s reliance on debt.

Question 24

How is minority interest treated in the NFO calculation?

Answer 24

It’s added to NFO, as it’s a non-equity claim on the firm’s value.

Question 25

How do preferred dividends affect net income?

Answer 25

They reduce income available to common shareholders - must be subtracted before computing ROE.

Question 26

What should you do before calculating ratios?

Answer 26

Check accounting quality; adjust for misleading classifications.

Question 27

What is the danger of comparing ratios across firms without adjustments?

Answer 27

Firms may use different accounting policies or have different business models.

Question 28

Why might a company report high ROE while destroying value?

Answer 28

Due to high leverage and a negative spread.

Question 29

What does consistent, positive spread over time indicate?

Answer 29

Sustainable value creation through wise capital deployment.

Question 30

What does a declining NOA turnover suggest?

Answer 30

Operational inefficiency or excessive asset build-up.

Question 31

Why is peer comparison valuable in ratio analysis?

Answer 31

It provides strategic context for interpreting margin and turnover figures.

Question 32

What role does tax play in advanced DuPont analysis?

Answer 32

It affects both NOI and the after-tax cost of debt, which changes spread and ROE.

Question 33

What does a firm with high ROE, low RNOA, and high leverage look like?

Answer 33

A financially engineered firm that might be riskier than it appears.

Question 34

How does financial leverage affect risk?

Answer 34

It amplifies both gains and losses, increasing volatility of equity returns.

Question 35

What is the primary use of DuPont analysis in practice?

Answer 35

To understand how a company earns its returns, and whether those returns are sustainable.

Question 36

What kind of firm would you expect to have low leverage and high RNOA?

Answer 36

A cash-rich, high-margin business like Apple or Google.

Question 37

When is time-series ratio analysis most useful?

Answer 37

When tracking a firm's internal progress over time.

Question 38

What do high turnover and low margin often indicate about capital intensity?

Answer 38

The firm likely operates in a lean, asset-light model.