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1、Discipline of Finance SILC Program Subject 25050 Lecture 8Slide 1Financial Valuation and StrategyReturn on Invested Capital and Profitability AnalysisLecture 8Discipline of Finance SILC Program Subject 25050 Lecture 8Slide 2Topics for Lecture 8Examine return and relate to risk level and level and so

2、urce of financingUnderstand different measures of return on invested capital and their interpretationUnderstand the role of leverageCalculate the components of return on capital employedRelate return and strategy to the global financial crisisHow does the GFC affect analysis?What is a CDO?Collateral

3、ized debt obligation basically a form of securitized debt such as mortgages where the cash flows are repackaged in a bundle and then flow through to investorsWhy do we care?Many financial products available world-wideEconomic turmoil affects consumers and changes demand for goods and servicesDiscipl

4、ine of Finance SILC Program Subject 25050 Lecture 8Slide 3Discipline of Finance SILC Program Subject 25050 Lecture 8Slide 4 Joint analysis is where one measure is assessed relative to another Return on invested capital (ROIC) is an important joint analysisNeed to calculate the RETURN And the INVESTE

5、D CAPITAL Return on Invested CapitalImportance of Joint AnalysisDiscipline of Finance SILC Program Subject 25050 Lecture 8Slide 5Return on Invested Capital ROI RelationROI relates e, or other performance measure, to a companys level and source of financingROI allows comparisons with alternative inve

6、stment opportunitiesRiskier investments are expected to yield a higher ROIROI impacts a companys ability to succeed, attract financing, repay creditors,and reward ownersDiscipline of Finance SILC Program Subject 25050 Lecture 8Slide 6Return on Invested CapitalApplication of ROI(1) measuring manageri

7、al effective-ness(2) measuring profitability(4) earnings forecasting(3) Measure for planning and controlROI is applicable to:Discipline of Finance SILC Program Subject 25050 Lecture 8Slide 7Return on Invested CapitalMeasuring Managerial Effectiveness Management is responsible for all company activit

8、iesROI is a measure of managerial effectiveness in business activities ROI depends on the skill, resourcefulness,ingenuity, and motivation of managementDiscipline of Finance SILC Program Subject 25050 Lecture 8Slide 8Return on Invested CapitalMeasuring Profitability ROI is an indicator of company pr

9、ofitabilityROI relates key summary measures: profits with financing ROI conveys return on invested capital from different financing perspectivesDiscipline of Finance SILC Program Subject 25050 Lecture 8Slide 9Return on Invested CapitalMeasurement for Planning and ControlROI assists managers with: Pl

10、anning Budgeting Coordinating activities Evaluating opportunities ControlDiscipline of Finance SILC Program Subject 25050 Lecture 8Slide 10Components of ROIDefinitionReturn on invested capital is defined as:Discipline of Finance SILC Program Subject 25050 Lecture 8Slide 11Components of ROIInvested C

11、apital Defined No universal measureof invested capital exists Different measures of invested capital reflect different financiers perspectivesDiscipline of Finance SILC Program Subject 25050 Lecture 8Slide 12Components of ROIAlternative Measures of Invested Capital Common Measures:Net Operating Asse

12、tsStockholders EquityDiscipline of Finance SILC Program Subject 25050 Lecture 8Slide 13Components of ROINet Operating AssetsPerspective is that of the company as a whole Called return on net operating assets (RNOA)RNOA:measures operating efficiency/ performancereflects return on net operating assets

13、 (excluding financial assets/liabilities)Discipline of Finance SILC Program Subject 25050 Lecture 8Slide 14Components of ROINet Operating Assets1. Net Operating Working Capital (excluding S-T investments and borrowings)2. L-T Operating assets less L-T operating LiabilitiesDiscipline of Finance SILC

14、Program Subject 25050 Lecture 8Slide 15Components of ROICommon Equity Capital Perspective is that of common equity holders Captures the effect of leverage (debt) capital on equity holder return Excludes all debt financing and preferred equityDiscipline of Finance SILC Program Subject 25050 Lecture 8

15、Slide 16Components of ROIComputing Invested CapitalUsually computed using average capital available for the periodTypically add beginning and ending invested capital amounts and divide by 2 More accurate computation is to average interim amounts quarterly or monthlyBUT IT COULD JUST USE THE ENDING V

16、ALUES! (if stable)Discipline of Finance SILC Program Subject 25050 Lecture 8Slide 17Components of ROI e DefinedDefinition of e (return) depends on definition of invested capital Measures of e in computing return on invested capital must reflect all applicable expenses from the perspective of the cap

17、ital contributors e taxes are valid deductions in computing e for return on invested capitalExamples: Return on net operating assets capital uses net operating profit after tax (NOPAT) Return on common equity capital uses net e less preferred dividends (not an expense in computing net e)Discipline o

18、f Finance SILC Program Subject 25050 Lecture 8Slide 18Components of ROIReturn on Net Operating Assets - RNOAWhere NOPAT = Operating e x (1- tax rate) NOA = net operating assetsDiscipline of Finance SILC Program Subject 25050 Lecture 8Slide 19Components of ROIReturn on Common Equity - ROCEWhereEquity

19、 is stockholders equity less preferred stockDiscipline of Finance SILC Program Subject 25050 Lecture 8Slide 20Analyzing Return on Assets-ROADisaggregating RNOAOperating Profit margin: measures operating profitability relative to salesOperating Asset turnover (utilization): measures effectiveness in

20、generating sales from operating assetsReturn on operating assets = Operating Profit margin x Operating Asset turnoverDiscipline of Finance SILC Program Subject 25050 Lecture 8Slide 21Analyzing Return on Assets-ROARelation Between Profit Margin and Asset TurnoverProfit margin and asset turnover are i

21、nterdependentADEGFHIBCYKJLNPXMODiscipline of Finance SILC Program Subject 25050 Lecture 8Slide 22Net operating Asset Turnover vs. Net operating Profit Margin for Selected IndustriesTypical QuestionWhy does a restaurant chain have a lower operating profit margin and higher net operating asset turnove

22、r than a pharmaceutical company?Profit margin is lower since restaurants cant typically command high profit margins.exception is celebrity chefs but then they dont have a high operating asset turnoverDiscipline of Finance SILC Program Subject 25050 Lecture 8Slide 23Discipline of Finance SILC Program

23、 Subject 25050 Lecture 8Slide 24Gross Profit Margin: Reflects the gross profit as a percent of sales- Reflects the companys ability to increase or maintain selling price- Declining gross profit margins generally indicate that competition has increased or that the companys products have e less compet

24、itive, or both. Operating Expense Margin: Measures the companys ability to control operating expenses - need to be aware of “investment” costs, like advertising and R&D. - Reductions can lead to a short-term gain at a long-term cost. Analyzing Return on Assets-ROADisaggregating Profit MarginAnother

25、typical exam question:Is it good or bad to reduce R&D expense?GoodMay improve profitability in the short termBadMay reduce profitability in the long termConclusionVery short sighted to reduce this cost in the short term and can lead to long term poor resultsUsually BAD!Discipline of Finance SILC Pro

26、gram Subject 25050 Lecture 8Slide 25Another typical exam question:Is it good or bad to reduce or change advertising expense?GoodMay improve profitability in the short termBadMay reduce profitability in the long termConclusionShort sighted to reduce this cost in the short term and can lead to long te

27、rm poor results HOWEVER when there are new advertising methods changing approaches may be good! Example online advertising tied into social networks!School of Finance and Economics SILC ProgramSubject 25050 Lecture 8Slide 26Discipline of Finance SILC Program Subject 25050 Lecture 8Slide 26Discipline

28、 of Finance SILC Program Subject 25050 Lecture 8Slide 27Analyzing Return on Assets-ROAAsset Turnover AnalysisAsset turnover measures the intensity with which companies utilize assetsRelevant measure is the amount of sales generatedDiscipline of Finance SILC Program Subject 25050 Lecture 8Slide 28Acc

29、ounts Receivable turnover: Reflects how many times receivables are collected on average. The panying ratio is the average collection period. Inventories turnover: Reflects how many times inventories are collected on average. The panying ratio is the average inventory days outstanding.Long-term Opera

30、ting Asset turnover: Reflects the productivity of long-term operating assets. Accounts Payable turnover: Reflects how quickly accounts payable are paid, on average. The panying ratio is the average payable days outstanding.Analyzing Return on Assets-ROADisaggregating Asset turnoverDiscipline of Fina

31、nce SILC Program Subject 25050 Lecture 8Slide 29Analyzing Return on Common Equity-ROCERole in Equity Valuationwhere ROCE is equal to net e available to common shareholders (after preferred dividends) divided by the beginning-of-period common equityThis can be restated in terms of future ROCE:Discipl

32、ine of Finance SILC Program Subject 25050 Lecture 8Slide 30Analyzing Return on Common Equity-ROCEDisaggregating ROCEDiscipline of Finance SILC Program Subject 25050 Lecture 8Slide 31Analyzing Return on Common Equity-ROALeverage and ROCELeverage refers to the extent of invested capital from other tha

33、n common shareholdersIf suppliers of capital (other than common shareholders) receive less than ROA, then common shareholders benefit; the reverse occurs when suppliers of capital receive more than ROAThe larger the difference in returns between common equity and other capital suppliers, the more successful (or unsuccessful) is the trading on the equityDiscipline of Finance SILC Pr