B3-M5

Question 1

Residual income (RI)

Answer 1

=Net income-Required return
Required return= NBV(equity)* hurdle rate
-maximize income in excess of $ amt
hurdle rate=historical WAAC
-

Question 2

Return on Investment (ROI)

Answer 2

=(Net) Income/ investment capital(average assets)
=Profit margin * Investment turnover
-may lead to rejecting projects that have a positive cash flow
-ST benefits are emphasized

Question 3

Economic Value added

Answer 3

=Net operating profit after taxes - Required return

• Required return= Investment *WACC
• RI technique that measures excess of income after taxes earned by an investment over defined rate of return(in excess of cost of capital)

Question 4

Profit margin

Answer 4

Income/ sales

Question 5

Investment (asset) turnover

Answer 5

Sales/ Invested capital (assets)

Question 6

Purchase of a LT asset

Answer 6

Decreases both ROI and RI

Question 7

Return on Equity (ROE)

Answer 7

=Net Income/ Equity

Question 8

DuPoint ROE

Answer 8

Net profit margin * Asset turnover * Financial leverage

Question 9

Net profit margin

Answer 9

Net income/ Sales

Question 10

Asset Turnover

Answer 10

Sales/ Assets

Question 11

Financial Leverage

Answer 11

Assets/Equity

Question 12

Earnings before profit interest and tax (EBIT)

Answer 12

=operating profit

margin= operating profit/ sales

Question 13

Return on Assets (ROA)

Answer 13

=Net Income/ Avg total assets

= Net profit margin* Asset turnover