How do you calculate Return on Equity?*

ROE is considered as...

Use it by looking at...

   Net Income   

Average Owner's Equity

 = RNOA + (Leverage * Spread)

"the ultimate measure of performance from the shareholders' POV."

The industry and our history trend...when trend is going UP, this is good!

1. Operations
2. Financing with debt (non-operating)

How do you calculate RNOA?

(Return on Net Operating Assets)

  NOPAT         (Net Operating Profit After Tax)

Average NOA                (Net Operating Assets)

Current/LT Operating Assets

- Current/LT Operating Liabilities

Sales

COGS

Gen/Admin Expense

R&D

Income Taxes

Dividens

Interest Revenue/Expense

Hedging Gains/Losses

Operating Income * (1 - Tax Expense/Pretax Income)

                            ^^ Effective Tax Rate

    Tax Expense   

Pretax Income

Return on financing

- Cost of financing

The extent that you are using debt vs. equity to finance your company.

*More debt = more leverage = more risk*

Receive Goods--------------------------Cash from Customer

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A/R                               Inventory                           A/P

Holding           +             Holding              -        Turnover

Period                            Period

     Current Assets     

Current Liabilities

(Cash - Marketable Securities + A/R)

Current Liabilities

Treasury stock is a contra-account.

When purchasing treasury stock...

both assets (cash) and stockholder's equity decrease.

(See Class #8 slides 57-58 for repurchase and resale of treasury stock)

Issued Shares 

   - Treasury Stock   

{__________}

EQUITY.

It always has priority on Dividend payout.

Typically, it does not vote.

When a company looking to raise cash issues additional shares of stock in exchange for cash, instead of issuing dividends.

(See Class #8 slide 74)

Small Stock: when it is less than 25%, we use Market Value, 150,000 * par value goes into common stock, the rest goes into "additional paid in capital"

Large Stock: when it is greater than 25%, we use Par Value, it goes straight into common stock, and decreases retained earnings by the same.

Large stock Dividends have no impact to Additional paid-in-capital

(See Class #8 Slides 75-76)

What is asset turnover? 

Why is it important?

    Net Income    

Average Total Assets

Asset Turnover measures productivity and is good when it is higher because it increases shareholder value.

ROE =

(in equation form)

   Gross Profit   

Sales

   Sales   

Average Accounts Receivable

        COGS        

Average Inventory

          COGS          

Average Accounts Payable

     Current Assets     

Current Liabilities

Cash

+ Marketable Securities

+ A/R

__________________

Current Liabilities

it takes more dollars to buy ONE Euro.

But when we translate European revenues into the US, our income increases.

it takes less dollars to buy ONE Euro.

But when we translate European revenues into the US, our income decreases.

Dollar Weakens = Assets, Liabilities and Income ___

Dollar Strenghtens =Assets, Liabilities and Income ___

$$ weakens = Income INCREASES

$$ strengthens = Income DECREASES

Fluctuations are held on the Balance Sheet because it is expected that fluctuations over time will balance out, therefore keeping it off the Income Statement.

Deferred Tax Asset Transaction: 

[image]

either a liability or assets account is adjusted.

(Deferred Tax Asset or Liability)

Timing Differences:

If it starts out as a Deferred Tax Liability/Deferred Tax Assets...

**Remember: When recording transaction, Cash and Rev/Exp are BOTH negative

When a company reports Net Loss in a previous period, it can carryforward that loss to decrease the amount of tax it pays on Net Income in a future period.

Ex/

2004 Net Loss: $50

2005 Net Income: $75

  Can carryforward the loss of $50, and therefore, only pay income tax on $25

Extraordinary items must be...

They are segregated from the...

1. Unusual

AND 

(Net Income - Preferred Dividends)

_________________________________

Weighted Average Common Stock

(Net Income - Preferred Dividends)

_________________________________

(Weighted Average Common Stock + an adjustment of additional shares of stock reflecting the effect of the potential exercise of the stock options)

See Slide 64 - 66

KNOW!!!

Capatalization of Operating Leases: int. rate = 7%

[image]

Capatalization of Operating Leases: int. rate = 7%

1. Operating: No asset/liability on balance sheet, Recorded as Rent Expense
2. Capital: Asset/Liability reported on the Balance Sheet, Asset is depreciated, Liability is amortized like a mortgage, Payments are seperated into interest expense and prinicipal repayment.

Reduce Cash

Reduce Retained Earnings as "Rent Expense"

For the Same Amount

1. Create a liability equal to the present value of the lease payments
2. Create an asset for an equal amount
3. Depreciate that asset over the lease term
4. Treat the lease payments as payments on the loan

See Slides 39-43 for illustration

**NEED TO KNOW THIS FOR EXAM!

PBO, beg

+ Service Cost

+ Interest Cost

+/- Actuarial gain/loss

- Benefits paid to employees

PBO, Ending

Pension Plan Assets, beg

+ Return on Plan Assets

+ Company Contributions

    - Benefits Paid                  

Pension Plan Assets, Ending

1. Passage of Time
2. Return on Assets
3. Service Cost

Pension Expense =

(according to GAAP)

Interest Cost

+ Service Cost

- Expected Return on Assets

+ Amortization of deferred amounts

(actuarial gains/losses^^)

The difference between

Actual return on Assets

-and-

Expected Return on Assets

Formed by a sponsoring company and is capitalized with an equity investment.

The SPE leverages this equity investment with borrowings from the debt market and purchases assets from, or for, the sponsoring company.

         Total Firm Value - Debt        

Total Outstanding Shares