Question 1

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

Accepted Answer

Return on equity (ROE) is a measure of profitability that shows how much profit a company has generated for each dollar of shareholder equity. It is calculated by dividing the company's net income by its shareholders' equity. ROE is not necessarily the return stockholders have realized during the past year.

Question 2

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.

Accepted Answer

ROCE measures the return earned on the capital invested by shareholders, while RNOA measures the return earned on the company's operating assets. By comparing the two, we can understand how effectively the company is using financial leverage to generate returns.

Question 3

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.

Accepted Answer

Return on net operating assets and return on equity are both affected by net operating profit margin, therefore a decrease in the margin will result in a decrease in both measures of profitability.

Question 4

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

Accepted Answer

ROSI (Return on Shareholders' Investment) is likely to be more volatile than ROCE (Return on Capital Employed) because it is influenced by changes in the stock market, which can fluctuate significantly, affecting the market value of equity and thus the return to shareholders.

Question 5

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

Accepted Answer

Deferred taxes are not deducted when calculating return on net operating assets (RNOA); instead, RNOA focuses on operating assets and liabilities, excluding tax-related items unless they directly relate to the operating activities.

Question 6

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.

Accepted Answer

The equity growth rate is primarily influenced by the Return on Capital Employed (ROCE) because it indicates how efficiently a company is using its capital to generate profits, which can be reinvested to grow equity. Higher dividend payouts actually reduce the amount of earnings that can be reinvested into the company, potentially lowering the equity growth rate. The cost of debt affects the company's overall cost of capital but does not directly influence the equity growth rate. Lastly, the equity growth rate does not directly indicate the expected growth in stock price each period, as stock prices are influenced by a variety of factors beyond just the equity growth rate.

Question 7

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?

Accepted Answer

Non-operating assets, such as marketable securities, should be excluded from the calculation of return on net operating assets (RNOA) because RNOA focuses on the profitability of the company's core operations. Marketable securities are typically considered non-operating assets.

Question 8

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

Accepted Answer

Net income in relation to invested capital (return on invested capital or ROIC) provides insight into how efficiently a company is using its capital to generate profits. Therefore, it is an important metric to consider when analyzing a company's performance.

Question 9

There is only one way to measure invested capital.

Accepted Answer

There are different ways to measure invested capital, such as including or excluding different types of capital, such as debt or equity. The method chosen may depend on the specific analysis or purpose for which invested capital is being measured.

Question 10

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.

Accepted Answer

This is because in a highly competitive industry, there are many firms vying for market share, resulting in lower prices and therefore lower profit margins. Additionally, with low barriers to entry, new firms can enter the industry easily, increasing competition and putting further pressure on profit margins. In contrast, companies operating in less competitive industries may have more pricing power and be able to command higher profit margins.

Question 11

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

Accepted Answer

A lower accounts receivable turnover ratio compared to the industry norm suggests that a company is slower in collecting its receivables. This could be due to customers being dissatisfied with the quality of products (inferior products), leading to delays in payments or disputes over payments.

Question 12

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

Accepted Answer

ROCE is calculated as (Net Income / Invested Capital) while RNOA is calculated as (Operating Profit / Operating Capital). Since both ROCE and RNOA include net income or operating profit, they will be equal if there is no interest expense. However, if there is interest expense, then ROCE will be higher than RNOA if RNOA is greater than after-tax cost of debt (which is included in the invested capital calculation). Hence, choice D is correct.

Question 13

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

Accepted Answer

When calculating return on equity (ROE), minority interest is not added to the numerator. ROE is calculated using net income attributable to shareholders of the parent company, which already accounts for minority interest in the calculation of net income.

Question 14

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

Accepted Answer

The accelerated depreciation method results in higher depreciation expenses in the early years of an asset's life, which reduces net income. This, in turn, results in a higher net operating asset turnover ratio.

Question 15

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.

Accepted Answer

Companies with low net operating profit margins have lower profitability and can only earn a reasonable return on net operating assets if they utilize their assets efficiently. This is because they earn less revenue per dollar of asset invested, so they need to make up for it by using those assets more efficiently.

Question 16

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?

Accepted Answer

The answer of Selected information for Acme Corp.:
 \(\begin{array}{lrrr}&\text {...

Question 17

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

Accepted Answer

The two components of Return on Net Operating Assets (RNOA), net operating profit margin and Net Operating Assets (NOA) turnover, are interrelated because both are derived from how efficiently a company uses its assets to generate profit. The net operating profit margin reflects the profitability of operations relative to sales, while NOA turnover indicates how effectively the company uses its net operating assets to generate sales. Changes in one can affect the other, indicating they are not independent.

Question 18

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?

Accepted Answer

The answer of Selected information for Acme Corp.:
 \(\begin{array}{lrrr}&\text {...

Question 19

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

Accepted Answer

The return on net operating assets (RNOA) is the ratio of operating income to net operating assets, while the pretax return on equity (ROE) is the ratio of pre-tax earnings to total equity. It is possible for the RNOA to be less than the ROE if the company has a high level of financial leverage (i.e. debt) and its pre-tax earnings are significantly higher than its operating income.

Question 20

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

Accepted Answer

Rapidly growing earnings per share (EPS) does not necessarily mean that the return on net operating assets (RNOA) is increasing. EPS growth can be influenced by factors such as share buybacks, financial leverage, or other non-operational activities that do not affect RNOA, which focuses on operational efficiency and profitability.

Quiz 8: Return on Invested Capital and Profitability Analysis

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

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.

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.

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

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

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

There is only one way to measure invested capital.

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.

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

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

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

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

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.

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

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

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