Class 4 - Value Creation

Question 1

What is cross-sectional comparison?

Answer 1

Analysts and managers compare ROE across companies, particularly in the same industry.

Question 2

What is a time-series comparison?

Answer 2

Analysts and managers compare a particular company’s ROE over time to determine whether the company became better at generating higher returns.

Question 3

What are the two broad drivers of ROE?

Answer 3

1 - the company’s operations

2 - the degree to which the company’s shareholders benefited from the company using debt financing.

Question 4

What is a Three-Component DuPont model used for?

Answer 4

Decomposing ROE

Question 5

What does a Three-Component DuPoint model consider?

Answer 5

Return on Assets (ROA)
Interest Efficiency
Leverage

Question 6

What does ROA measure?

Answer 6

The companies profitability from operations

Question 7

How is ROA calculated?

Answer 7

ROA = NOPAT / Average Total Assets

Question 8

Why is Net Income not used to calculate ROA?

Answer 8

ROA measures how well the company used ALL its assets to generate income for ALL the investor groups who funded the company’s assets, not how well it used assets funded by one investor to generate income for that one investor group.

Question 9

True or False - a companies ROA is changes based on its capital structure?

Answer 9

False - it is independent of how assets are funded.

Question 10

What does NOPAT stand for?

Answer 10

Net Operating Profit After Tax (NOPAT)

Question 11

What does NOPAT measure?

Answer 11

the income that the company generated from its operations that is available to split between the company’s creditors and shareholders.

Question 12

What does Leverage measure?

Answer 12

The extent to which the company has funded assets via debt financing.

Question 13

What does Interest Efficiency measure?

Answer 13

The cost of debt financing. Specifically, it measures how much NOPAT is left for shareholders after covering the cost of debt financing.

Question 14

Intuitive definition of ROA

Answer 14

The value created by an entity’s assets in a given period. Regardless of the entity’s capital structure

Question 15

Intuitive definiton of ROE

Answer 15

The value and entity creates for its shareholders. It is calculated after an entity has met its other financing obligations such as interest payments on debt.

Question 16

T or F: The cost of equity is driven by both Micro and Macro economic factors?

Answer 16

True - macro markets; change of risk free rate

micro factors; change of company capital structure,

Question 17

NOPAT is technically given by?

Answer 17

Net Income (NI) + (1 - Corp Tax Rate, Tc) * (Interest Expense)

Question 18

What is a Second Order Effect?

Answer 18

The effect on the other DePont variables due to the intentional increase of one.

Question 19

Definition of Asset Turnover?

Answer 19

Sales / Average Total Assets

Question 20

Definition of Operating Efficiency?

Answer 20

NOPAT / Sales

Question 21

Intuitive meaning of Asset Turnover?

Answer 21

A company’s ability to use its assets to generate revenue.

Question 22

Intuitive meaning of Operating Efficiency?

Answer 22

Measures a company’s ability to manage its operating expenses. The higher this ratio the better, it measures the dollar amount kept by a company for each dollar of revenue.

Question 23

Definition of Interest Efficiency?

Answer 23

Net Income / NOPAT

Question 24

Definition of Leverage?

Answer 24

Ave Total Assets / Ave Shareholder Equity

Question 25

What are the two categories of follow up analyses for Asset Turnover?

Answer 25

1 - Divide the company’s assets into sub-groupings

2 - Divide the company’s operations into business segments and/or geographic segments.

Question 26

List the 6 types of Asset Turnover followup analyses.

Answer 26

1 - PP&E turnover
2 - Intangible turnover
3 - Receivable turnover
4 - inventory turnover
5 - payable turnover
6 - segment analysis

Question 27

List 3 types of Operating Efficiency follow-up analyses.

Answer 27

1 - Common-size
2 - Income statement
3 - segment analysis

Question 28

List 2 types of Interest Efficiency follow-up analyses.

Answer 28

1 - Current ratio

2 - Quick ratio

Question 29

List 3 types of Leverage follow-up analyses.

Answer 29

1 - Liabilities-to-equity
2 - Debt-to-equity
3 - Interest coverage

Question 30

What is a Common-Size Income Statement?

Answer 30

An income statement that is standardised by stating each item as a percentage of NET SALES.