Question

A firm made a significant increase in the firm’s marketing expense towards the end of the fiscal year 2019. Since the marketing splurge is so late in the fiscal year, there is no expected increase in revenue in 2019. Explain how this investment would impact the firm’s Asset Turnover, operating margin, FCF, EVA, and TSR in 2019? In your opinion, how did this decision impact the firm’s financial performance in 2019 (increase, decrease, neutral, or not sure)? Explain!

Answer 1

We know, the increased marketing expenses were primarily done towards the end of 2019. Hence, the firm also does not expect to see any increase in revenue in 2019. So, all we have is increased expenses in its operations and decrease in assets but the same level of revenue. Therefore, asset turnover ratio will reduce.(= revenues/asset)

Operating margin will also reduce as expense increases. (Operating margin = sales - cost).

Since net income decreases with increased operational expenses (marketing expense), free cash flow (FCF) will also reduce.

Again, EVA = NOPAT - (Invested Capital * WACC), wher NOPAT is Net operating profit after taxes, WACC is Weighted average cost of capital. Although not sure about WACC, it can fairely assessed that since margin will reduce, NOPAT will also fall and hence EVA will also likely to go down.

We know that profit will fall. But we cannot be sure that the Total shareholder return (TSR) will fall, If the company decides to absorb the marketing expenses fully and not adjust it into shareholder return (such as dividend), then it can pass on the same levels of dividend/return (or it can be even made higher upon management's discretion!) to the shareholders. Increased marketing expenses do not make us sure about its effect on TSR.

Inline with the above justifications, it can be said that the company's financial performance got relatively decreased with increase in marketing expenses. However, from a shareholder's return perspective, it cannot be concluded either way.