FIN 520 CSU Global Campus Module 5 Profitability Analysis Exercises and Problems

User Generated

xfcea

Economics

FIN 520

Colorado State University Global Campus

FIN

Description

Option #1: Profitability Analysis Exercises and Problems

Do the assigned problems using Summer Peebles, Inc.'s condensed 2014 financial data below:

Assets

Current Assets

$250,000.00

Noncurrent Assets

$1,750,000.00

Total Assets

$2,000,000.00

Liabilities and Equity

Current Liabilities

$200,000.00

Noncurrent Liabilities (8% Bonds)

$675,000.00

Common Stockholders' Equity

$1,125,000.00

Total Liabilities and Equity

$2,000,000.00

Additional Information:

  • Net income for 2014 is $157,500.
  • Income tax rate is 50%.
  • Amounts for total assets and shareholders' equity are the same for 2013 and 2014.
  • All assets and current liabilities are considered to be operating.

Required:

  • Determine whether leverage (from long-term debt) benefits Peeble’s shareholders. (Hint: Examine ROCE with and without leverage.)
  • Compute the NOPAT and RNOA (use ending NOA).
  • Demonstrate the favorable effect of leverage given the disaggregation of ROCE and your answer to part (B).

Your submission should: Be 1-2 pages for the written portion (can be excel if that is what is needed, and text boxes for further explanations)

References:

Benoit, D. (2016). Finance's hot new metric: ROIC. Wall Street Journal.

Gallo A. (2016). A refresher on return on assets and return on equity. Harvard Business Review Digital Articles. 2-6. (To view this reading, please open the link provided and download the “PDF full text.”)

Subramanyam, K. (2014). Financial statement analysis (11th ed.). New York, NY: McGraw Hill.

Unformatted Attachment Preview

Option #1: Profitability Analysis Exercises and Problems Do the assigned problems using Summer Peebles, Inc.'s condensed 2014 financial data below: Assets Current Assets $250,000.00 Noncurrent Assets $1,750,000.00 Total Assets $2,000,000.00 Liabilities and Equity Current Liabilities $200,000.00 Noncurrent Liabilities (8% Bonds) $675,000.00 Common Stockholders' Equity $1,125,000.00 Total Liabilities and Equity $2,000,000.00 Additional Information: • • • • Net income for 2014 is $157,500. Income tax rate is 50%. Amounts for total assets and shareholders' equity are the same for 2013 and 2014. All assets and current liabilities are considered to be operating. Required: 1. Determine whether leverage (from long-term debt) benefits Peeble’s shareholders. (Hint: Examine ROCE with and without leverage.) 2. Compute the NOPAT and RNOA (use ending NOA). 3. Demonstrate the favorable effect of leverage given the disaggregation of ROCE and your answer to part (B). Your submission should: Be 1-2 pages for the written portion (can be excel if that is what is needed, and text boxes for further explanations) • • Include the Excel spreadsheet with computations. Clearly separate your responses so your instructor knows the problems you are answering. WATCH THIS VIDEO LINK BELOW FOR FURTHER UNDERSTANDING!! • • https://csuglobal.zoom.us/rec/play/oU-HWf-l1h4GTg8hDUhzMFUDIAv0ENMQjJbLpfut0EjkuaOLdge6zXYfLlC-D3vrPJB-C9teSUgO70c.EXs5vS99ue_0btny FIN520week five (2) (2).mp4 References: Benoit, D. (2016). Finance's hot new metric: ROIC. Wall Street Journal. Gallo A. (2016). A refresher on return on assets and return on equity. Harvard Business Review Digital Articles. 2-6. (To view this reading, please open the link provided and download the “PDF full text.”) Subramanyam, K. (2014). Financial statement analysis (11th ed.). New York, NY: McGraw Hill. ADDITIONAL INFORMATION FOR FURTHER UNDERSTANDING: Analyzing ROIC: Return on Net Operating Assets (RNOA) As previously stated, ROIC is an important metric in assessing a company’s profitability. You can use several ratios to measure ROIC. Return on net operating assets (RNOA) utilizes rate of return of operating activities in profitability analysis. Operating activities are the core activities of a company including: 1. on the income statement: sales, cost of goods sold, and operating expenses. 2. on the balance sheet: assets and liabilities that relate the operating activities on the income statements such as accounts receivable, inventories, property, plant, and equipment, accounts payable, and accrued expenses (Subramanyam, 2014). RNOA is calculated as NOPAT divided by Average NOA. Your textbook discusses this calculation in detail. To make RNOA more meaningful and provide better insight in profitability analysis, it may be necessary to disaggregate RNOA. RNOA = NOPAT Average NOA By disaggregating, you break the RNOA calculation into components like this: NOPAT = NOPAT X Sales Average NOA Sales Average NOA Return on net operating assets Net operating profit margin Net operating asset turnover The net operating profit margin is the ability of an organization to generate earnings at a particular sales level while the net operating asset turnover is the ability of an organization to manage the level of investment in assets for a particular sales level. Put another way, net operating profit margin is the ability to use sales to generate profits and net operating asset turnover is the ability to use assets to generate sales. These components of RNOA vary across industries depending on the economic characteristics and even vary across organizations in an industry based on the strategies employed. Hence, as has been discussed many times, you need to adjust the financial statement numbers when analyzing RNOA. This will ensure that you use appropriately adjusted financial statement numbers (Subramanyam, 2014). ADDITIONAL INFORMATION FOR FURTHER UNDERSTANDING: Analyzing ROIC: Return on Common Equity (ROCE) The main difference between RNOA and return on common equity (ROCE) or simply return on equity (ROE) is how you analyze the company’s performance. As you just explored, RNOA is a profitability measure from an operating activities standpoint. In other words, RNOA measures a firm’s operational profitability before considering financing effects. Conversely, ROCE is a profitability measure from an equity point of view. It measures common shareholders’ return after subtracting from revenues operating expenses and cost of financing debt and preferred stock. Hence, ROCE comprises RNOA and non-operating return components. RNOA is a profitability measure of operating activities while the non-operating component reflects the favorable or unfavorable effects of financial leverage (Subramanyam, 2014). As expected, ROCE is important to common shareholders. ROCE is calculated as: Net income – Preferred stock dividends Average common shareholders’ equity In analyzing ROCE, you can disaggregate it for better analysis. Net income – Preferred stock dividends Net income – = Preferred stock dividends Average X Sales X assets Average common shareholders’ equity Sales Average assets Average common shareholders’ equity Return on common shareholders’ equity Adjusted profit margin Asset turnover Leverage The adjusted profit margin indicates the earnings allocable to common shareholders after subtracting from revenues all operating expenses and financing costs of capital with higher ranking than common shareholders. Asset turnover is the ability of an organization to manage the level of investment in assets for a particular sales level. The leverage ratio measures the degree to which a company utilizes financial leverage to finance assets. As in the case of RNOA and other financial analysis discussed in earlier modules, you need to adjust the financial statement numbers when analyzing RNOA. This will ensure that you use appropriately adjusted financial statement numbers. 1 Profitability Analysis Exercises and Problems Cori White Colorado State University Global FIN 520: Financial Reporting and Analysis Dr Williams March 14, 2021 This study source was downloaded by 100000808075316 from CourseHero.com on 02-17-2022 17:09:35 GMT -06:00 https://www.coursehero.com/file/85560742/FIN-520-Mod-5-Opt-1doc/ 2 Profitability Analysis Exercise and Problems + 1. Determine if leverage (from log-term debt) benefits Rose’s shareholders. a. Financial leverage represents the magnitude of which a company uses its income debt securities to obtain more assets. “Financial leverage is the use of debts to finance the purchase of assets with the expectation that the income or capital gain from the new asset will exceed the cost of borrowing” (CFI, n.d.). Looking at the computations, notated in the spreadsheet, the ROCE is 14%, with leverage. However, to calculate the ROCE without leverage, a provision is made for the interest expense of half of the total interest charged, which is $27,000; to get this we take 4% * 675,000. Net income without leverage is calculated by adding net income and saved interest together, in this situation, the net earnings are $184,500. Without leverage, the return on investment is 10.25%. Leveraging is helpful for shareholders as they will have a higher return than they would get without leveraging. 2. Compute the NOPAT and RNOA (use ending NOA) a. NOPAT is Net Operating Profit After Tax and is essentially an organization’s operating income if they did not have debt (CFI, n.d.). To calculate RNOA or return on net operating assets, you divide profits after taxes by the net operating assets (NOA) (Accounting Hub, 2020). (See the excel sheet to for computations.) 3. Demonstrate the favorable effect of leverage given in the disaggregation of ROCE and your answer to part B. a. Because the ROCE with leverage is higher than the return on ROCE without leverage, the favorable effect of leverage can be seen. Leverage is the total This study source was downloaded by 100000808075316 from CourseHero.com on 02-17-2022 17:09:35 GMT -06:00 https://www.coursehero.com/file/85560742/FIN-520-Mod-5-Opt-1doc/ 3 company debt divided by the shareholder’s equity (O’Connell, 2018). In this situation it would be 675,000 / 1,125,000 = 60%. The leverage is 14% and the favorable effect is 3.75%, as you can see in the attached spreadsheet. The favorable effect percentage shows the amount of earnings a stockholder will give up if the organization does not leverage. With that being said, it would be beneficial to an organization to have long-term debts because of their positive effects on earnings. This study source was downloaded by 100000808075316 from CourseHero.com on 02-17-2022 17:09:35 GMT -06:00 https://www.coursehero.com/file/85560742/FIN-520-Mod-5-Opt-1doc/ 4 References Accounting Hub. (2020). Return on Net Operating Assets (RNOA): Definition, formula, and how to calculate it. Retrieved from: https://www.accountinghub-online.com/return-on-netoperating-assets-rnoa/ CFI. (n.d.). NOPAT. Retrieved from: https://corporatefinanceinstitute.com/resources/knowledge/valuation/what-is-nopat/ CFI. (n.d.). What is financial leverage. Retrieved from: https://corporatefinanceinstitute.com/resources/knowledge/finance/financial-leverage/ O’Connell., B. (2018). What Is Leverage in Finance and What Is the Formula? Retrieved from: https://www.thestreet.com/personal-finance/education/what-is-leverage-finance14700895 This study source was downloaded by 100000808075316 from CourseHero.com on 02-17-2022 17:09:35 GMT -06:00 https://www.coursehero.com/file/85560742/FIN-520-Mod-5-Opt-1doc/ Powered by TCPDF (www.tcpdf.org)
Purchase answer to see full attachment
User generated content is uploaded by users for the purposes of learning and should be used following Studypool's honor code & terms of service.

Explanation & Answer

View attached explanation and answer. Let me know if you have any questions.

Option #1: Profitability Analysis Exercises and Problems

Option #1: Profitability Analysis Exercises and Problems

Name

Course
Instructor's Name
Date

1

Option #1: Profitability Analysis Exercises and Problems
Option #1: Profitability Analysis Exercises and Problems
The first part of the exercise determines whether the usage of leverage is beneficial
for the company’s shareholders or not. For this purpose, ROCE is calculated with leverage by
dividing the company’s net income of 157,500 with its current common equity of 1,125,000.
The resultant ROCE with leverage comes at 14%. Now to calculate ROCE without leverage,
all of the company's capital will be assumed as equity, substituting long-term debt as well.
(Warren et al., 2016)
The revised equity will be $1,800,000. Next, the interest expense and its related tax
savings will be adjusted in the net income. Interest expense of (8% x 675,000) 54,000 will be
added back while its tax saving of ...

Similar Content

Related Tags