Deck 8: Return on Invested Capital and Profitability Analysis

Question 1

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.
$$\begin{array} { l r r } & \text { NOPAT margin } & \text { Net operating asset turnover } \\\text { Industry A } & 8.0 \% & 1.5 \\\text { Industry B } & 1.2 \% & 5.5 \\\text { Industry C } & 5.4 \% & 1.0\end{array}$$
Match the industry to A, B or C

$\begin{array}{lll}&\text { Grocery Retail } & \text { Oil and Gas } & \text { Drug } \\A.&\text { B } & \text { C } & \text { A } \\B.&\text { B } & \text { A } & \text { C } \\C.&\text { C } & \text { A } & \text { B } \\D.&\text { C } & \text { B } & \text { A }\end{array}$

A)Option A
B)Option B
C)Option C
D)Option D

Answer 1

Option A

Question 2

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

Answer 2

C

Question 3

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

Answer 3

C

Question 4

a. Niglow Corporation produces metal castings. In the past year it earned a 10% return on its net operating assets base of $10 million. Niglow needs $10 million 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 5

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 6

You are given the following data for Good Company Inc. for 2004, 2005, and 2006 (amounts in thousands).
$\begin{array}{lrrr}&2006&2005&2004\\\text { Net income } & \$ 445 & \$ 402 & \$ 345 \\\text { Average number of common shares outstanding } & 135 & 134 & 132 \\\text { Average common shareholder' equity } & \$ 1,231 & \$ 964 & \$ 735\end{array}$
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 7

$$\begin{array} { l r r } \text { Operating assets } & \underline { 2005 } & \underline { 2004 } \\\text { Short-term debt } & 10,500 & \$ 10,000 \\\text { Long-term debt } & 3,5000 & 1,000 \\\text { Minority interest } & 500 & 4,000 \\\text { Common equity } & 5,500 & 5,000 \\& & \\\text { Operating income } & 1,350 & \\\text { Interest expense } & 350 & \\\text { Tax expense } ( 40 \% ) & 400 & \\\text { Minority interest } & 50 & \\\text { Net income } & 550 &\end{array}$$

-Return on common equity for 2005 is:

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

Question 8

$$\begin{array} { l r r } & \underline { 2006 } & \underline { 2005 } \\\text { Current assets } & \$ 4,650 & \$ 4,730 \\\text { Long-term assets } & 7,120 & 6,450 \\\text { Current liabilities } & 1,440 & 1,340 \\\text { Long-term debt } & 3,830 & 3,760 \\\text { Common equity } & 6,500 & 6,080 \\& & \\\text { Operating income } & 2,140 & \\\text { Interest expense } & 240 & \\\text { Tax expense } ( 40 \% ) & 760 & \\\text { Net income } & 1,140 &\end{array}$$
Assume all assets are operating assets; all current liabilities are operating liabilities.

-Return on net operating assets for 2006 is:

A)11.30%.
B)12.03%.
C)9.93%.
D)11.19%.

Question 9

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)Estate tax rate
B)Marginal tax rate
C)Statutory federal tax rate
D)Statutory federal tax rate plus statutory state tax rate

Question 10

Below are selected ratios for Widget Corporation and Tools Inc. Use this information to answer the following questions. $\begin{array}{c}\begin{array}{ll}\\\text { 1. } & \text { Net operating asset turnover } \\\text { 2. } & \text { Inventory turnover } \\\text { 3. } & \text { Accounts receivable turnover } \\\text { 4. } & \text { Fixed assets turnover } \\\text { 5. } & \text { Net operating profit margin } \\\text { 6. } & \text { Assets-to-equity } \\\text { 7. } & \text { EBIT/revenues } \\\text { 8. } & \text { Gross margin } \\\text { 9. } & \text { Income tax rate }\end{array}\begin{array}{rr}\text { Widget Corp.}&\text { Tools, Inc. }\\2.0 & 2.0 \\4.6 & 4.0 \\12.0 & 12.0 \\1.8 & 2.0 \\4.5 \% & 2.9 \% \\2.10 & 3.3 \\9.9 \% & 8.6 \% \\21.1 \% & 19.8 \% \\35 \% & 35 \% \end{array}\end{array}$


a. Which company has a higher return on equity?
b. 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. 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 11

Err Company has a major lawsuit against them for unsafe products. It recognizes a huge liability in 2004 of $300 million. 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 12

$$\begin{array} { l r r } & \underline { 2006 } & \underline { 2005 } \\\text { Current assets } & \$ 4,650 & \$ 4,730 \\\text { Long-term assets } & 7,120 & 6,450 \\\text { Current liabilities } & 1,440 & 1,340 \\\text { Long-term debt } & 3,830 & 3,760 \\\text { Common equity } & 6,500 & 6,080 \\& & \\\text { Operating income } & 2,140 & \\\text { Interest expense } & 240 & \\\text { Tax expense } ( 40 \% ) & 760 & \\\text { Net income } & 1,140 &\end{array}$$
Assume all assets are operating assets; all current liabilities are operating liabilities.

-Return on equity for 2006 is:

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

Question 13

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 14

Below are selected ratios for Manufacturers Corporation. Use this information answer the following questions. $\begin{array}{llrr}&\text { Year } 1&\text { Year } 2&\text { Year } 3\\\text { 1. Net operating asset turnover } & 1.4 & 1.31 & 1.25 \\\text { 2. Inventory turnover } & 5.6 & 5.0 & 4.6 \\\text { 3. Accounts receivable turnover } & 12.1 & 11.9 & 12.1 \\\text { 4. Fixed assets turnover } & 1.3 & 1.29 & 1.29 \\\text { 5. Net operating profit margin } & 4.5 \% & 4.6 \% & 4.8 \% \\\text { 6. Net operating assets/equity } & 2.10 & 1.98 & 1.77 \\\text { 7. EBIT/revenues } & 8.9 \% & 8.6 \% & 8.6 \% \\\text { 8. Gross margin } & 20.1 \% & 19.9 \% & 19.8 \% \\\text { 9. Income tax rate } & 35 \% & 35 \% & 35 \%\end{array}$
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 15

Indicate the effect of the following transactions on:
i. Return on net operating assets (RNOA)
ii. Return on common shareholders' equity (ROCE)
iii. Earnings per share (basic)
Consider each transaction independently and explain your answer. Assume that ROCE is higher than RNOA.1. Company issues more preferred stock and uses proceeds to reduce accounts payable.2. Company has a stock split.3. 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 16

$$\begin{array} { l r r } \text { Operating assets } & \underline { 2005 } & \underline { 2004 } \\\text { Short-term debt } & 10,500 & \$ 10,000 \\\text { Long-term debt } & 3,5000 & 1,000 \\\text { Minority interest } & 500 & 4,000 \\\text { Common equity } & 5,500 & 5,000 \\& & \\\text { Operating income } & 1,350 & \\\text { Interest expense } & 350 & \\\text { Tax expense } ( 40 \% ) & 400 & \\\text { Minority interest } & 50 & \\\text { Net income } & 550 &\end{array}$$

-Return on operating assets for 2005 is:

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

Question 17

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.3. ABC uses FIFO and XYZ uses LIFO (assuming normal economic conditions)
4. ABC sold receivables at face value at the end of the year.

Question 18

$\begin{array} { l r r } \text { Long-term debt } & 7,709 & 8,508 \\ \text { Long-tern obligations under capital leases } & 2,307 & 2,092 \\ \text { Deferred income taxes and other } & 463 & 400 \\ \text { Minority interest } & 1,025 & 331 \end{array}$
Shareholders' equity:
Preferred stock ( $\$ .10$ par value; 100 shares authorized, none issued)
Common stock ( $\$ .10$ par value; 5,500 shares authorized, 2,285 and
$\begin{array}{lrr}2,293 \text { issued and outstanding in X6 and X7, respectively) } & 228 & 229 \\\text { Capital in excess of par value } & 547 & 545 \\\text { Retained earnings } & 16,768 & 14,394 \\\text { Foreign currency translation adjustment } & \underline{(400)}&\underline{(412)} \\\quad \text { Total shareholders' equity }&\underline{17,143}&\underline{14,756} \\\text { Total liabilities and shareholders' equity }& \underline{\$ 39.604} & \underline { \$ 37.541} \end{array}$

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 19

Eyster Corporation reported $10 million in earnings and paid dividends of $3 million 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 100 million. 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)$110 million.
B)$107 million.
C)$101 million.
D)not determinable.

Question 20

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.1. Non-operating asset adjustment
2. Intangible asset adjustment
3. Accumulated depreciation adjustment

Question 21

The following information relates to Yutter Corporation:
$\begin{array}{lr}&\text { Year } 1\\\text { Net income-year ended } 12 / 31 & \$ 12,500 \\\text { Dividends } & 3,000 \\\text { Return on net operating assets } & 13 \% \\\text { Return on equity } & 15 \% \\\text { Cost of equity } & 12 \%\end{array}$

-What is Yutter's sustainable equity growth rate?

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

Question 22

The following information relates to Yutter Corporation:
$\begin{array}{lr}&\text { Year } 1\\\text { Net income-year ended } 12 / 31 & \$ 12,500 \\\text { Dividends } & 3,000 \\\text { Return on net operating assets } & 13 \% \\\text { Return on equity } & 15 \% \\\text { Cost of equity } & 12 \%\end{array}$

-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 23

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 24

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

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

Question 25

Widget Co. and Tools Inc. both operate in the same industry. They are capital-intensive companies producing widgets. Below are selected data:
$\begin{array}{lll}&\text { Widget Co. }&\text { Tools Inc. }\\\text { Net operating assets/common equity } & 1.37 & 1.53 \\\text { Net operating profit margin } & 19 \% & 21 \% \\\text { Income tax rate } & 47 \% & 28 \% \\\text { Revenues/net operating assets } & 0.81 & 0.61 \\\text { EBIT/revenues } & 38 \% & 32 \%\end{array}$

-Which of the following statements is the most plausible explanation of the difference in observed net operating profit margins?

A)Widget Co's lower financial leverage
B)Widget Co uses LIFO and Tools uses FIFO
C)Widget Co's lower tax rate
D)Widget Co's net operating asset turnover

Question 26

Widget Co. and Tools Inc. both operate in the same industry. They are capital-intensive companies producing widgets. Below are selected data:
$\begin{array}{lll}&\text { Widget Co. }&\text { Tools Inc. }\\\text { Net operating assets/common equity } & 1.37 & 1.53 \\\text { Net operating profit margin } & 19 \% & 21 \% \\\text { Income tax rate } & 47 \% & 28 \% \\\text { Revenues/net operating assets } & 0.81 & 0.61 \\\text { EBIT/revenues } & 38 \% & 32 \%\end{array}$

-Widget has a higher EBIT/Revenue but lower net operating profit margin than Tool. Which of the following statements could explain this better 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 27

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

Question 28

Below is selected information from Tricrop. $\begin{array}{lll}&\underline{\text { Year } 1} &\underline{\text { Year } 2}\\\text { Net operating assets/common equity } & 1.37 & 1.53 \\\text { Net operating profit margin } & 19 \% & 21 \% \\\text { Income tax rate } & 47 \% & 28 \% \\\text { Revenues/average net operating } & 0.81 & 0.61 \\\text { assets } & & \\\text { EBIT/revenues } & 38 \% & 32 \%\end{array}$

-Return on common equity for Year 1 is:

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

Question 29

Which of the following will cause an increase in net operating income (NOPAT)?

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)There is not sufficient information

Question 30

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 31

Below is selected information from Tricrop. $\begin{array}{lll}&\underline{\text { Year } 1} &\underline{\text { Year } 2}\\\text { Net operating assets/common equity } & 1.37 & 1.53 \\\text { Net operating profit margin } & 19 \% & 21 \% \\\text { Income tax rate } & 47 \% & 28 \% \\\text { Revenues/average net operating } & 0.81 & 0.61 \\\text { assets } & & \\\text { EBIT/revenues } & 38 \% & 32 \%\end{array}$

-Return on net operating assets for Year 1 is:

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

Question 32

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 33

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

A)Option A
B)Option B
C)Option C
D)Option D

Question 34

Widget Co. and Tools Inc. both operate in the same industry. They are capital-intensive companies producing widgets. Below are selected data:
$\begin{array}{lll}&\text { Widget Co. }&\text { Tools Inc. }\\\text { Net operating assets/common equity } & 1.37 & 1.53 \\\text { Net operating profit margin } & 19 \% & 21 \% \\\text { Income tax rate } & 47 \% & 28 \% \\\text { Revenues/net operating assets } & 0.81 & 0.61 \\\text { EBIT/revenues } & 38 \% & 32 \%\end{array}$

-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 35

The following information relates to Yutter Corporation:
$\begin{array}{lr}&\text { Year } 1\\\text { Net income-year ended } 12 / 31 & \$ 12,500 \\\text { Dividends } & 3,000 \\\text { Return on net operating assets } & 13 \% \\\text { Return on equity } & 15 \% \\\text { Cost of equity } & 12 \%\end{array}$

-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 decrease.
C)the value of the stock would decrease.
D)the return on net operating assets would decrease.

Question 36

Widget Co. and Tools Inc. both operate in the same industry. They are capital-intensive companies producing widgets. Below are selected data:
$\begin{array}{lll}&\text { Widget Co. }&\text { Tools Inc. }\\\text { Net operating assets/common equity } & 1.37 & 1.53 \\\text { Net operating profit margin } & 19 \% & 21 \% \\\text { Income tax rate } & 47 \% & 28 \% \\\text { Revenues/net operating assets } & 0.81 & 0.61 \\\text { EBIT/revenues } & 38 \% & 32 \%\end{array}$

-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 37

Cost of goods sold divided by inventory provides information about:

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

Question 38

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 39

Widget Co. and Tools Inc. both operate in the same industry. They are capital-intensive companies producing widgets. Below are selected data:
$\begin{array}{lll}&\text { Widget Co. }&\text { Tools Inc. }\\\text { Net operating assets/common equity } & 1.37 & 1.53 \\\text { Net operating profit margin } & 19 \% & 21 \% \\\text { Income tax rate } & 47 \% & 28 \% \\\text { Revenues/net operating assets } & 0.81 & 0.61 \\\text { EBIT/revenues } & 38 \% & 32 \%\end{array}$

-Which of the following statements best explains the difference in observed net operating asset turnover?

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

Question 40

Purchases divided by accounts payable provides information about:

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

Question 41

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

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

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 44

Widget Co. and Tools Inc. both operate in the same industry. They are capital-intensive companies producing widgets. Below are selected data:

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 45

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

Question 46

Widget Co. and Tools Inc. both operate in the same industry. They are capital-intensive companies producing widgets. Below are selected data:

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 47

Selected information for Acme Corp.:
$\begin{array}{lrrr}&\text { Year } 1&\text { Year } 2&\text { Year } 3\\\text { Cash } & \$ 1,000 & \$ 1,500 & \$ 1,500 \\\text { Marketable securities } & 8,000 & 2,000 & 2,000 \\\text { Accounts receivable, net } & 2,000 & 3,000 & 2,500 \\\text { Other current assets } & 2,500 & 3,000 & 3,000 \\\text { Property, plant, and equipment } & 4,500 & 6,000 & 7,000 \\\text { Less: accumulated depreciation } & (4,000) & (4,200) & (4,400) \\\text { Goodwill and other intangibles } & 5,000 & 7,500 & 1,000\end{array}$

-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)Non-operating asset adjustment
D)No asset adjustment

Question 48

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

Question 49

There is only one way to measure invested capital.

Question 50

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 51

Widget Co. and Tools Inc. both operate in the same industry. They are capital-intensive companies producing widgets. Below are selected data:

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 under-estimating bad debts.

Question 52

Widget Co. and Tools Inc. both operate in the same industry. They are capital-intensive companies producing widgets. Below are selected data:

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 53

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

Question 54

Widget Co. and Tools Inc. both operate in the same industry. They are capital-intensive companies producing widgets. Below are selected data:

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 the accelerated depreciation method while competitors use the straight line method.
D)The company purchases more credit supplies than competitors.

Question 55

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 56

Selected information for Acme Corp.:
$\begin{array}{lrrr}&\text { Year } 1&\text { Year } 2&\text { Year } 3\\\text { Cash } & \$ 1,000 & \$ 1,500 & \$ 1,500 \\\text { Marketable securities } & 8,000 & 2,000 & 2,000 \\\text { Accounts receivable, net } & 2,000 & 3,000 & 2,500 \\\text { Other current assets } & 2,500 & 3,000 & 3,000 \\\text { Property, plant, and equipment } & 4,500 & 6,000 & 7,000 \\\text { Less: accumulated depreciation } & (4,000) & (4,200) & (4,400) \\\text { Goodwill and other intangibles } & 5,000 & 7,500 & 1,000\end{array}$

-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)Operating asset adjustment
D)No asset adjustment

Question 57

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

Question 58

Selected information for Acme Corp.:
$\begin{array}{lrrr}&\text { Year } 1&\text { Year } 2&\text { Year } 3\\\text { Cash } & \$ 1,000 & \$ 1,500 & \$ 1,500 \\\text { Marketable securities } & 8,000 & 2,000 & 2,000 \\\text { Accounts receivable, net } & 2,000 & 3,000 & 2,500 \\\text { Other current assets } & 2,500 & 3,000 & 3,000 \\\text { Property, plant, and equipment } & 4,500 & 6,000 & 7,000 \\\text { Less: accumulated depreciation } & (4,000) & (4,200) & (4,400) \\\text { Goodwill and other intangibles } & 5,000 & 7,500 & 1,000\end{array}$

-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)Tangible asset adjustment
C)Non-operating asset adjustment
D)No asset adjustment

Question 59

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

Question 60

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

Question 61

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 62

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

Question 63

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

Question 64

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

Question 65

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 66

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 67

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.

Question 68

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 69

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 70

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

Question 71

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

Question 72

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

Question 73

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

Question 74

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 75

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

Question 76

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