Slide 1Slide 2Return on Invested CapitalSlide 4Slide 5Slide 6Slide 7Slide 8Components of ROISlide 10Slide 11Slide 12Slide 13Slide 14Slide 15Slide 16Slide 17Slide 18Analyzing Return on Assets-ROAEffect of Operating Leverage on RNOAProfit Margin and Asset TurnoverSlide 22Slide 23Slide 24Slide 25Slide 26Slide 27Slide 28Slide 29Analyzing Return on Common Equity-ROCESlide 31Slide 32Slide 33Slide 34Slide 35Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/IrwinFinancial Statement AnalysisK R SubramanyamJohn J Wild8-28CHAPTE RReturn on Invested Capital and Profitability Analysis8-3Return on Invested Capital• Joint analysis is where one measure is assessed relative to another• Return on invested capital (ROIC) or Return on Investment (ROI) is an important joint analysis• Joint analysis is where one measure is assessed relative to another• Return on invested capital (ROIC) or Return on Investment (ROI) is an important joint analysisImportance of Joint Analysis8-4Return on Invested CapitalROI Relation•ROI relates income, or other performance measure, to a company’s level and source of financing•ROI allows comparisons with alternative investment opportunities•Riskier investments expected to yield a higher ROI•ROI impacts a company’s ability to succeed, attract financing, repay creditors,and reward owners•ROI relates income, or other performance measure, to a company’s level and source of financing•ROI allows comparisons with alternative investment opportunities•Riskier investments expected to yield a higher ROI•ROI impacts a company’s ability to succeed, attract financing, repay creditors,and reward owners8-5Return on Invested CapitalApplication of ROI(2) measuring profitability(3) Measure for planning and control(1)measuring managerial effectiveness(2)measuring Profitability(3)measure for planning and control ROI is applicable to:8-6Return on Invested CapitalMeasuring Managerial Effectiveness• Management is responsible for all company activities• ROI is a measure of managerial effectiveness in business activities• ROI depends on the skill, resourcefulness,ingenuity, and motivation of management• Management is responsible for all company activities• ROI is a measure of managerial effectiveness in business activities• ROI depends on the skill, resourcefulness,ingenuity, and motivation of management8-7Return on Invested CapitalMeasuring 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• ROI is an indicator of company profitability• ROI relates key summary measures: profits with financing• ROI conveys return on invested capital from different financing perspectives8-8Return on Invested CapitalMeasuring for Planning and ControlROI assists managers with:• Planning• Budgeting• Coordinating activities• Evaluating opportunities• ControlROI assists managers with:• Planning• Budgeting• Coordinating activities• Evaluating opportunities• Control8-9Components of ROI•Return on invested capital is defined as:IncomeInvested Capital8-10Components of ROIInvested Capital Defined• No universal measureof invested capital • Different measures of invested capital reflect user’s different perspectives8-11Components of ROIAlternative Measures of Invested Capital Common Measures:• Net Operating Assets• Stockholders’ Equity8-12Components of ROI• Perspective is that of the company as a whole • Called return on net operating assets (RNOA)RNOA: measures operating efficiency/ performance reflects return on net operating assets (excluding financial assets/liabilities)• Perspective is that of the company as a whole • Called return on net operating assets (RNOA)RNOA: measures operating efficiency/ performance reflects return on net operating assets (excluding financial assets/liabilities)Net Operating Assets8-13Components of ROICommon Equity Capital• Perspective is that of common equity holders• Captures the effect of leverage (debt) capital on equity holder return• Excludes all debt financing and preferred equity• Perspective is that of common equity holders• Captures the effect of leverage (debt) capital on equity holder return• Excludes all debt financing and preferred equitynet income less preferred dividendsaverage common equity8-14Components of ROIComputing 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 amounts — quarterly or monthly8-15Components of ROIAdjustments to Invested Capital and Income NumbersMany accounting numbers require analytical adjustment—see prior chaptersSome numbers not reported in financial statements need to be includedSuch adjustments are necessary for effective analysis of return on invested capitalMany accounting numbers require analytical adjustment—see prior chaptersSome numbers not reported in financial statements need to be includedSuch adjustments are necessary for effective analysis of return on invested capital8-16Components of ROIReturn on Net Operating Assets -- RNOANOPAT(Beginning NOA + Ending NOA) / 2NOPAT(Beginning NOA + Ending NOA) / 2Where• NOPAT = Operating income x (1- tax rate)• NOA = net operating assets8-17Components of ROIBALANCE SHEETOperating assets ..................... OALess operating liabilities ........ (OL)Net operating assets.............. NOAFinancial liabilities .................. FLLess financial assets ............. (FA)Net financial obligations......... NFOStockholders’ equity................ SENet financing ................ NFO + SEOperating and nonoperating activities - Distinction8-18Components of ROIReturn on Common Equity -- ROCENet income - Preferred dividends(Beginning equity + Ending equity) / 2Net income - Preferred dividends(Beginning equity + Ending equity) / 2Where• Equity is stockholder’s equity less preferred stock8-19Analyzing Return on Assets-ROADisaggregating RNOAReturn on operating assets = Operating Profit margin x Operating Asset turnoverNOA Avg.SalesSalesNOPATNOA Avg.NOPATOperating Profit margin: measures operating profitability relative to salesOperating Asset turnover (utilization): measures effectiveness