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1、Chapter 8Return on invested capital and profitability analysis,1,Outline:,Return on Invested Capital Components of ROI Analyzing Return on Assets-ROA Analyzing Return on Common Equity-ROCE,2,Return on Invested Capital, Joint analysis is where one measure is assessed relative to another Return on inv
2、ested capital (ROIC) or Return on Investment (ROI) is an important joint analysis,Importance of Joint Analysis,3,Return on Invested Capital,ROI Relation,ROI allows us to assess companies on their success with invested capital. ROI allows comparisons with alternative return on investment Riskier inve
3、stments expected to yield a higher ROI ROI impacts a companys ability to succeed, attract financing, repay creditors,and reward owners,4,Return on Invested Capital,Application of ROI,(2) measuring profitability,(3) Measure for planning and control,(1) measuring managerial effectiveness,(2) measuring
4、 Profitability,(3) measure for planning and control,ROI is applicable to:,5,Return on Invested Capital,Measuring Managerial Effectiveness, Management is responsible for all company activities ROI is a measure of managerial effectiveness in business activities ROI depends on the skill, resourcefulnes
5、s, ingenuity, and motivation of management,6,Return on Invested Capital,Measuring Profitability, ROI is an indicator of company profitability ROI relates key summary measures: profits with financing ROI conveys return on invested capital from different financing perspectives,7,Return on Invested Cap
6、ital,Measuring for Planning and Control,ROI assists managers with: Planning Budgeting Coordinating activities Evaluating opportunities Control,8,Components of ROI,Return on invested capital is defined as:,9,Components of ROI,Invested Capital Defined, No universal measure of invested capital Differen
7、t measures of invested capital reflect users different perspectives,10,Components of ROI,Alternative Measures of Invested Capital,Common Measures: Net Operating Assets Stockholders Equity,11,Components of ROI, Perspective is that of the company as a whole Called return on net operating assets (RNOA)
8、 RNOA: measures operating efficiency/ performance reflects return on net operating assets (excluding financial assets/liabilities),Net Operating Assets,12,Components of ROI,Common Equity Capital, Perspective is that of common equity holders Captures the effect of leverage (debt) capital on equity ho
9、lder return Excludes all debt financing and preferred equity,13,Components of ROI,Computing Invested Capital,Usually computed using average capital available for the period Typically add beginning and ending invested capital amounts and divide by 2 More accurate computation is to average interim amo
10、unts quarterly or monthly,14,Components of ROI,Adjustments to Invested Capital and Income Numbers,Many accounting numbers require analytical adjustmentsee prior chapters Some numbers not reported in financial statements need to be included Such adjustments are necessary for effective analysis of ret
11、urn on invested capital,15,Components of ROI,Return on Net Operating Assets - RNOA,NOPAT (Beginning NOA + Ending NOA) / 2,Where NOPAT = Operating income x (1- tax rate) NOA = net operating assets,16,Components of ROI,Operating and nonoperating activities - Distinction,17,Components of ROI,Return on
12、Common Equity - ROCE,Net income - Preferred dividends (Beginning equity + Ending equity) / 2,Where Equity is stockholders equity less preferred stock,18,Analyzing Return on Assets-ROA,Disaggregating RNOA,Return on operating assets = Operating Profit margin x Operating Asset turnover,Operating Profit
13、 margin: measures operating profitability relative to sales Operating Asset turnover (utilization): measures effectiveness in generating sales from operating assets,19,Profit Margin and Asset Turnover,Profit margin and asset turnover are interdependent Profit margin is a function of sales and operat
14、ing expenses (selling price x units sold) Turnover is also a function of sales (sales/assets),20,Profit Margin and Asset Turnover,Relation between NOPAT Margin, NOA Turnover, and Return on Net Operating Assets,21,Profit Margin and Asset Turnover,Net operating Asset Turnover v/s Net operating Profit
15、Margin for Selected Industries,22,Analyzing Return on Assets-ROA,23,Analyzing Return on Assets-ROA,Disaggregating Profit Margin,Operating profit margin (OPM) =,Pretax PM = Pretax sales PM + Pretax other PM,24,Analyzing Return on Assets-ROA,Gross Profit Margin: Reflects the gross profit as a percent
16、of sales Reflects companys ability to increase or maintain selling price Declining margins may indicate that competition has increased or that the companys products have become less competitive, or both Selling Expenses General and Administrative Expenses,Disaggregating Profit Margin,25,Analyzing Re
17、turn on Assets-ROA,Disaggregation of Asset Turnover, Asset turnover measures the intensity with which companies utilize assets Relevant measure is the amount of sales generated,Sales average net operating assets,26,Analyzing Return on Assets-ROA,Accounts Receivable turnover: Reflects how many times
18、receivables are collected on average. Accompanying ratio: Average collection period Inventories turnover: Reflects how many times inventories are collected on average Accompanying ratio: Average inventory days outstanding Long-term Operating Asset turnover: Reflects the productivity of long-term ope
19、rating assets Accounts Payable turnover: Reflects how quickly accounts payable are paid, on average Accompanying ratio: Average payable days outstanding,Disaggregation of Asset Turnover,27,Analyzing Return on Assets-ROA,Disaggregation of Asset Turnover,28,Analyzing Return on Common Equity-ROCE,where
20、 ROCE is equal to net income available to common shareholders (after preferred dividends) divided by the beginning-of-period common equity,This can be restated in terms of future ROCE:,Role in Equity Valuation,29,Analyzing Return on Common Equity-ROCE,Disaggregating ROCE,30,Analyzing Return on Commo
21、n Equity-ROCE,Leverage refers to the extent of invested capital from other than common shareholders If suppliers of capital (other than common shareholders) receive less than ROA, then common shareholders benefit; the reverse occurs when suppliers of capital receive more than ROA The larger the diff
22、erence in returns between common equity and other capital suppliers, the more successful (or unsuccessful) is the trading on the equity,Leverage and ROCE,31,Analyzing Return on Common Equity-ROCE,Alternate View of ROCE Disaggregation,32,Analyzing Return on Common Equity-ROCE,Assessing Equity Growth, Assumes earnings retention and a constant dividend payout Assesses common equity growth rate through earnings retention,33,Analyzing Return on Common Equity-ROCE,Assessing Equity Growth,Assumes internal growth depends on both earnings retention and return earned on the earnings retained,34,