Class 4 - Value Creation Flashcards
What is cross-sectional comparison?
Analysts and managers compare ROE across companies, particularly in the same industry.
What is a time-series comparison?
Analysts and managers compare a particular company’s ROE over time to determine whether the company became better at generating higher returns.
What are the two broad drivers of ROE?
1 - the company’s operations
2 - the degree to which the company’s shareholders benefited from the company using debt financing.
What is a Three-Component DuPont model used for?
Decomposing ROE
What does a Three-Component DuPoint model consider?
Return on Assets (ROA)
Interest Efficiency
Leverage
What does ROA measure?
The companies profitability from operations
How is ROA calculated?
ROA = NOPAT / Average Total Assets
Why is Net Income not used to calculate ROA?
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.
True or False - a companies ROA is changes based on its capital structure?
False - it is independent of how assets are funded.
What does NOPAT stand for?
Net Operating Profit After Tax (NOPAT)
What does NOPAT measure?
the income that the company generated from its operations that is available to split between the company’s creditors and shareholders.
What does Leverage measure?
The extent to which the company has funded assets via debt financing.
What does Interest Efficiency measure?
The cost of debt financing. Specifically, it measures how much NOPAT is left for shareholders after covering the cost of debt financing.
Intuitive definition of ROA
The value created by an entity’s assets in a given period. Regardless of the entity’s capital structure
Intuitive definiton of ROE
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.
T or F: The cost of equity is driven by both Micro and Macro economic factors?
True - macro markets; change of risk free rate
micro factors; change of company capital structure,
NOPAT is technically given by?
Net Income (NI) + (1 - Corp Tax Rate, Tc) * (Interest Expense)
What is a Second Order Effect?
The effect on the other DePont variables due to the intentional increase of one.
Definition of Asset Turnover?
Sales / Average Total Assets
Definition of Operating Efficiency?
NOPAT / Sales
Intuitive meaning of Asset Turnover?
A company’s ability to use its assets to generate revenue.
Intuitive meaning of Operating Efficiency?
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.
Definition of Interest Efficiency?
Net Income / NOPAT
Definition of Leverage?
Ave Total Assets / Ave Shareholder Equity
What are the two categories of follow up analyses for Asset Turnover?
1 - Divide the company’s assets into sub-groupings
2 - Divide the company’s operations into business segments and/or geographic segments.
List the 6 types of Asset Turnover followup analyses.
1 - PP&E turnover 2 - Intangible turnover 3 - Receivable turnover 4 - inventory turnover 5 - payable turnover 6 - segment analysis
List 3 types of Operating Efficiency follow-up analyses.
1 - Common-size
2 - Income statement
3 - segment analysis
List 2 types of Interest Efficiency follow-up analyses.
1 - Current ratio
2 - Quick ratio
List 3 types of Leverage follow-up analyses.
1 - Liabilities-to-equity
2 - Debt-to-equity
3 - Interest coverage
What is a Common-Size Income Statement?
An income statement that is standardised by stating each item as a percentage of NET SALES.
