In: Accounting
Question 2. Industry effect on the strcuture of ROE (35%)
Below are summarized balance sheets and income statements of three US companies :
Income Statement (in millions) |
|||
Firm 1 |
Firm 2 |
Firm 3 |
|
Revenues |
166.809 |
7.132 |
22.956 |
Earnings before interest and tax |
10.105 |
1.419 |
10.937 |
Earning before tax |
9.083 |
1.114 |
14.275 |
Earnings after tax |
5.745 |
714 |
9.421 |
Balance Sheet |
|||
Firm 1 |
Firm 2 |
Firm 3 |
|
Cash |
1.856 |
485 |
23.798 |
Accounts Receivable |
1.341 |
770 |
3.250 |
Inventories |
19.793 |
223 |
0 |
Prepaid Expenses |
1.366 |
237 |
3.260 |
Net Fixed Assets |
45.993 |
13.816 |
21.842 |
Total Assets |
70.349 |
15.531 |
52.150 |
Short-term debt |
5.408 |
890 |
0 |
Account payable |
13.105 |
616 |
1.083 |
Accrued Expenses |
7.290 |
158 |
8.672 |
Long-term liabilitites |
18.712 |
8.205 |
1.027 |
Owner’s Equity |
25.834 |
5.662 |
31.368 |
Total Liabilities and Owners’ equity |
70.349 |
15.531 |
52.150 |
DISCCLAIMER :
Values as provided in the problem : as Balance sheet total of Firm-3 is not getting tallied by 10.00 and in Short term Debt section it was 0 so its assumed that it is 10 instead of 0 and remaining calculation are based on this assumption
Balance sheet | Firm 1 | Firm 2 | Firm 3 |
Cash | 1.856 | 0.485 | 23.798 |
Accounts Receivable | 1.341 | 0.770 | 3.250 |
Inventories | 19.793 | 0.223 | 0 |
Prepaid Expenses | 1.366 | 0.237 | 3.260 |
Net Fixed Assets | 45.993 | 13.816 | 21.842 |
Total Assets | 70.349 | 15.531 | 52.150 |
Short-term debt | 5.408 | 0.890 | 10.000 |
Account payable | 13.105 | 0.616 | 1.083 |
Accrued Expenses | 7.290 | 0.158 | 8.672 |
Long-term liabilitites | 18.712 | 8.205 | 1.027 |
Owner’s Equity | 25.834 | 5.662 | 31.368 |
Total Liabilities and Owners’ equity | 70.349 | 15.531 | 52.150 |
1.
Working Capital Requirement | Firm 1 | Firm 2 | Firm 3 |
Cuurent Asset | |||
Accounts Receivable | 1.341 | 0.77 | 3.25 |
Inventories | 19.793 | 0.223 | 0 |
other Current Assets | |||
Prepaid Expenses | 1.366 | 0.237 | 3.26 |
(A) | 22.5 | 1.23 | 6.51 |
Cuurent Liabilty | |||
Account payable | 13.105 | 0.616 | 1.083 |
Accrued Expenses | 7.29 | 0.158 | 8.672 |
(B) | 20.395 | 0.774 | 9.755 |
Working Capital (WCR) (A-B) | 2.105 | 0.456 | -3.245 |
managerial balance sheet | Firm 1 | Firm 2 | Firm 3 |
Invested Capital | |||
Cash | 1.856 | 0.485 | 23.798 |
WCR | 2.105 | 0.456 | -3.245 |
Net Fixed Assets | 45.993 | 13.816 | 21.842 |
Total Invested Capital | 49.954 | 14.757 | 42.395 |
Capital Employed | |||
Short-term debt | 5.408 | 0.890 | 10.000 |
Long term Financing | |||
Long-term liabilitites (LT) | 18.712 | 8.205 | 1.027 |
Owner’s Equity (E) | 25.834 | 5.662 | 31.368 |
Total Long Term Financing (LT + E) | 44.546 | 13.867 | 32.395 |
Total Capital Employed | 49.954 | 14.757 | 42.395 |
Net Long term Financing = (Long term liabillity - net Fixed Asset) | -1.447 | 0.051 | 10.553 |
Net Short ter, Financing = Short term Debt -Cash | 3.552 | 0.405 | -13.798 |
Liquidity Ratio (net long term Financing/ WCR) | -0.68741 | 0.111842 | -3.25208 |
2.
Firm 1 | Firm 2 | Firm 3 | |
Operating Margin | 6.06% | 19.90% | 47.64% |
Invested Capital Turnover (times) | 3.34 | 0.48 | 0.54 |
return on capital employed | 20.23% | 9.62% | 25.80% |
Finance leverage Multiplier | 1.738 | 2.046 | 1.764 |
Tax effect | 63.25% | 64.09% | 66.00% |
ROE | 22.24% | 12.61% | 30.03% |
Such Ratios help in better understanding of the financial of organzation like Firm 3 has high ROE with high Operating Margin while Firm 1 have lowest oprating profit margin but overall its giving good return on Equity
Working
Income Statement | Firm 1 | Firm 2 | Firm 3 |
Revenues | 166.81 | 7.132 | 22.956 |
Earnings before interest and tax (EBIT) | 10.105 | 1.419 | 10.937 |
Earning before tax (EBT) | 9.083 | 1.114 | 14.275 |
Tax (EBT-EAT) | 3.338 | 0.400 | 4.854 |
Earnings after tax (EAT) | 5.745 | 0.714 | 9.421 |
Operating Margin = (Revenue/ EBIT) * 100 | 6.06% | 19.90% | 47.64% |
Total Invested Capital (TIC) | 49.954 | 14.757 | 42.395 |
Invested Capital Turnover (times) = Revenue/Total invested Capital | 3.34 | 0.48 | 0.54 |
Total Capital Employed | 49.954 | 14.757 | 42.395 |
return on capital employed = (EBIT/ total Capital Employe) * 100 | 20.23% | 9.62% | 25.80% |
Owner’s Equity | 25.834 | 5.662 | 31.368 |
Pretax return on Equity = EBT/ Owners' Equity | 35.16% | 19.68% | 45.51% |
pre tax return on invested capital =EBIT/Invested capita | 20.23% | 9.62% | 25.80% |
Finance leverage Multiplier= (pretax return on Equity/ pretax return on invested capital) | 1.738 | 2.046 | 1.764 |
Tax effect =(EAT/EBT) * 100 | 63.25% | 64.09% | 66.00% |
Effective Tax rate = (1- tax effect) | 36.75% | 35.91% | 34.00% |
ROE = (EAT/ Owner's Equity) * 100 | 22.24% | 12.61% | 30.03% |
3.
Firm 1 is retail (nongrocery) industry as it compete on price as evidenced by lower operating profit margin with high capital turnover ration in the group. Second in Pre-tax ROE is compesated by highest effective tax rate |
Firm 2 is utility firm; with second highest in oprating margin and ROE with bottom in ROCE hence its has average perfomance in the group as belongs to uility industry. |
Firm 3 is software industry as it has highest ROE (30.03%) this is beacuse of highest operating margin in the group. That could become possible as software has relatively high market share with less expensive to produce |