Question

Below is selected information from Tricrop:

	Year 1	Year 2
Net operating assets/common stock	1.37	1.53
Net operating profit margin	19%	21%
Income tax rate	47%	28%
Revenues/average net operating assets	0.81	0.61
EBIT/revenues	38%	32%

Which of the following is correct concerning changes at Tricrop from Year 1 to Year 2?

	RNOA	ROCE
Option A	Increased	Increased
Option B	Increased	Decreased
Option C	Decreased	Decreased
Option D	Decreased	Increased

Group of answer choices

Option A

Option D

Option C

Option B

Answer 1

Soluton:

The solution is choice 4 i.e. Option B (RNOA: Increased and ROCE: Decreased)

Workings are shown below:

1. RNOA (Return on Net Operating Assets)

Formula: Net operating profit margin x (1 - tax rate) x Revenue / Average net operating assets

Explanation: Net operating profit margin is the ratio of Operating Profit to Revenue. It is multiplied by (1 - tax rate) to find after tax net operating profit margin and then multiplied by Revenue / Average net operating assets ratio to get After tax operting profit / Average net operating assets ratio which is RNOA.

Calculation:

		Year 1	Year 2
A	Net operating profit margin	19%	21%
B	tax rate	47%	28%
C	1-tax rate (1 - B)	0.53	0.72
D	Revenues/average net operating assets	0.81	0.61
E	RNOA (A x C X D)	0.08	0.09

Thus, RNOA has increased from 0.08 to 0.09.

2. ROCE (Return on Capital Employed)

Formula: EBIT/revenues x Revenues/average net operating assets x Net operating assets/common stock

Explanation: ROCE is Earnings before interest and tax (EBIT) divided by Capital Employed (Total assets - Current Liabilities or Equity + Long Term Debt and in this case since there is only equity and no debt mentioned, the denominator would contain common stock only). We have used the ratios EBIT/revenues and  Revenues/average net operating assets to eliminate their denominators with Net operating assets/common stock and get EBIT / common stock which is nothing but ROCE.

Calculation:

		Year 1	Year 2
A	EBIT/revenues	38%	32%
B	Revenues/average net operating assets	0.81	0.61
C	Net operating assets/common stock	1.37	1.53
D	ROCE (A x B x C)	0.42	0.30

Thus, ROCE has decreased from 0.42 to 0.30.