Question

In: Finance

Q1: ROE, ROA, ROIC are given for Company A and Company B (unrelated to Flash Memory)....

Q1: ROE, ROA, ROIC are given for Company A and Company B (unrelated to Flash Memory).
Company A Company B
Interest rate 6.0% 8.0%
Income tax rate 17.0% 17.0%
Debt 585 100
Equity 348 833
TOTAL LIAB+EQUITY 933 933
EBIT 86 86
- Interest expense 35.1 8
Earnings before tax 50.9 78
- Income tax 8.7 13.3
Earnings after tax 42.2 64.7
Ratio Fraction Ratio Fraction Numerator Denominator
RETURN ON EQUITY (ROE) 12.1% 42.2/348 7.8% 64.7/833 Earnings after tax Equity
RETURN ON ASSETS (ROA) 4.5% 42.2/933 6.9% 64.7/933 Earnings after tax Total Liab+Equity
RETURN ON INVESTED CAPITAL (ROIC) 7.7% 86*.83/933 7.7% 86*.83/933 EBIT * (1-Tax rate) Total Liab+Equity

1a: Why is Company A ROE higher than Company B ROE? Is it better? Why? Why not?

1b: Why is Company A ROA lower than Company B ROA? What does it tell you about the two companies?
1c: How do the Company A & Company B ROICs compare? What does this suggest about the two companies?

Solutions

Expert Solution

1.a) The RoE of Company A is higher than company B because the amount of equity in the company A is lower than that in Company B. Since RoE is only concerned with Net income and equity it does not take into account the bankruptcy cost which are associated with having a large amount of debt on the Company balance sheet. Therefore, although the RoE of the company A is higher, it is not necessary good as the Company A is a lar amount of Debt which needs to be serviced regularly. As can be seen, the interest amount Company A pays is much larger than Company B. Therefore, care should be taken while interpreting RoE. Since, Company A is riskier, equity investors demand a higher return, hence RoE of Company A is high.

1.b) Since both companies have an equal asset base of 933, RoA shows which company is better at generating returns from the assets deployed. Clearly, Company B is better at converting assets in net income as it generated 64.7 units of net income as against 42.2 units of net income in Company A. Thus, it shows that Company B utilizes its assets better than Company A, eben though Company A has a higher RoE, Company B is more efficient overall.

1.c) ROIC is equal for both companies. it shows that the both the companies generate same amount of net operating income returns. Taking 1.a and 1.b into account, it can be said that the difference in returns of RoE and RoA is only due to the capital structure of the companies.


Related Solutions

What happens to ROA / ROE / ROIC if the company needs additional funding, which it...
What happens to ROA / ROE / ROIC if the company needs additional funding, which it raises through additional equity ?
BEP, ROE, AND ROIC Broward Manufacturing recently reported the following information: Net income $285,000 ROA 10%...
BEP, ROE, AND ROIC Broward Manufacturing recently reported the following information: Net income $285,000 ROA 10% Interest expense $91,200 Accounts payable and accruals $950,000 Broward's tax rate is 35%. Broward finances with only debt and common equity, so it has no preferred stock. 40% of its total invested capital is debt, while 60% of its total invested capital is common equity. Calculate its basic earning power (BEP), its return on equity (ROE), and its return on invested capital (ROIC). Round...
This particular company has an ROE of 13.25%, but an ROA of 1.47%. It has 75.5%...
This particular company has an ROE of 13.25%, but an ROA of 1.47%. It has 75.5% of its assets in Long-term Investments, and most of the rest is in Cash and Cash Equivalents. On the Liabilities side, Current Liabilities almost match Long-term Investments. It has an Equity Multiplier of 9.15. This company is a/an: Commercial Bank Savings & Loan Investment Bank Insurance Company Investment Company
Company has an ROA of 8.4 percent, a profit margin of 9.50 percent, and an ROE...
Company has an ROA of 8.4 percent, a profit margin of 9.50 percent, and an ROE of 15.50 percent. Requirement 1: What is the company’s total asset turnover? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)   Total asset turnover times Requirement 2: What is the equity multiplier? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)   Equity multiplier times
1) Based on the calculation , discuss relationship between ROA anfd ROE A company Z company...
1) Based on the calculation , discuss relationship between ROA anfd ROE A company Z company Average of ROA 12% 10% Standard deviation of ROA 5.89% 5.57% Standard deviation of ROE 8.45% 7.13% 2) which company has higher ROE and what is the reason of it? 3) which company has more volatility of roe and what is the reason of it ?
Q1/ A- What is cache memory and how it works? B- What are the three cache...
Q1/ A- What is cache memory and how it works? B- What are the three cache mapping approaches and what is the pros and cons of each approach? C- What is the cache replacement policies and read/write policies?
The Rangoon Timber Company has the following ratios: Net sales/Total assets = 2.26; ROA 8.95%; ROE...
The Rangoon Timber Company has the following ratios: Net sales/Total assets = 2.26; ROA 8.95%; ROE 17.09%. What are Rangoon’s profit margin and debt ratio? (Round answer to 2 decimal places, e.g. 12.55 or 12.55%.) Rangoon’s profit margin is % and its debt ratio is .
1. Fill in the blanks and give reasons: Company A Company B ROE 8% 8% Profit...
1. Fill in the blanks and give reasons: Company A Company B ROE 8% 8% Profit Margin % 7% 4% TAT 1.7 3.0 ROA 11% 8.7% Generic Strategy? A. Fill in the generic strategy row above. (5 points) The answer the following questions: B. How different are the two firms’ financials? Explain each ratio. (5 points) C. How are they related to their strategies? (5 points) A. How would you interpret a current ratio of 0.8? (2 points) B. Is...
Q1/Given the following information about the returns of stocks A, B, and C, what is the...
Q1/Given the following information about the returns of stocks A, B, and C, what is the expected return of a portfolio invested 30% in stock A, 40% in stock B, and 30% in stock C? State of economy Probability Stock A Stock B Stock C Boom 0.15 0.24 0.31 0.23 Good 0.21 0.19 0.14 0.12 Poor 0.25 0.01 0.08 0.04 Bust -- -0.29 -0.16 -0.19 Enter answer in percents. Q2/GIMP Inc., is trying to determine its cost of debt. The...
Q1/Given the following information about the returns of stocks A, B, and C, what is the...
Q1/Given the following information about the returns of stocks A, B, and C, what is the expected return of a portfolio invested 30% in stock A, 40% in stock B, and 30% in stock C? State of economy Probability Stock A Stock B Stock C Boom 0.12 0.2 0.23 0.37 Good 0.24 0.15 0.12 0.18 Poor 0.25 0 0.08 0.09 Bust -- -0.13 -0.2 -0.18 Enter answer in percents. Q2/A stock has an expected return of 10.2 percent, the risk-free...
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT