Performance Management: Part 2 - Module 5

Question 1

Return on Investment (ROI)

Answer 1

ROI provides for the assessment of a company’s percentage return relative to its capital investment risk. The ROI is an ideal performance measure for investment strategic business units.

Question 2

ROI Formula =

Answer 2

ROI = Income / Investment Capital
or
ROI = Profit margin x Investment turnover

Question 3

ROI Flowchart

Answer 3

Return on Investment (ROI)
= Profit Margin x Investment turnover
= Income / Sales Sales / Invested Capital

Question 4

Return on Assets

Answer 4

ROA = Net Income / Average total assets

Question 5

Return on Equity Formula

Answer 5

ROE = Net Income / Equity

Question 6

DuPont ROE =

Answer 6

DuPont ROE =
Net profit margin x Asset T/O x Financial Leverage
Net Income / Sales x Sales / Assets x Assets / Equity
OR
DuPont ROE = ROA X Financial Leverage

Question 7

Extended DuPont Model

Answer 7

Extended DuPont Model further breaks out Net Profit Margin into 3 distinct components: Tax burden, interest burden, & the operating income margin.

Question 8

Tax Burden - extent to which a company retains profits after paying taxes

Answer 8

Tax burden = Net Income / Pretax income

Question 9

Interest Burden - reflects how much in pretax income a company retains after paying interest to debt holders

Answer 9

Interest burden = Pretax income / EBIT

Question 10

EBIT MARGIN = Operating Income margin - is a measure of company profits earned on sales after paying operating & nonoperating costs (other than interest & taxes).

Answer 10

EBIT Margin = EBIT / Sales

Question 11

Extended DuPont ROE Formula - The last two components of the ROE calculation remain the same, with extended model

Answer 11

Extended DuPont ROE =
Tax bur. x Interest Bur. x EBIT Mar. x Asset T/O x Fin Lev
= NI / Pretax Income x Pretax Income / EBIT X
EBIT / Sales x Sales / Assets x Assets/Equity

Question 12

Pass Key

Answer 12

Average assets &; average equity should be used when calculating ROE. However, if a CPA Exam question only gives ending assets and/or ending equity, these amounts may be used to calculate ROE.

Question 13

Residual Income

Answer 13

RI measures the excess of actual income earned by an investment over the return required by the company. The rate of return/hurdle rate for the company may be its WACC, cost of equity, or it may simply be the return established by management as a target rate.

Question 14

Residual Income Formula

Answer 14

RI = Net income(IS) - minus Required return(WACC)
WHERE
Required return = Net book value (Equity) x Hurdle rate

Question 15

Economic Value Added - measures the excess of income after taxes (not counting interest expense) earned by an investment over the return rate defined by the company’s overall cost of capital (WACC)

Answer 15

Economic value added = Net operating profit after taxes (NOPAT) - minus Required return
WHERE:
Required return = Investment x wacc

Question 16

Net Profit Margin

Answer 16

Net Profit Margin is a measure of an entity’s profitability. Measure of operating efficiency.
Profit Margin = Net Income / Sales
Solve for NI —Profit Margin = Investment / Asset T/O

Question 17

Asset Turnover

Answer 17

Asset T/O - measure of how successfully the company uses assets to generate sales. Degree of efficiency with which a company is using its assets
Asset T/O = Sales / Assets

Question 18

Financial Leverage

Answer 18

measures percentage of capital structure funded with equity relative to debt. Should always be > 1.

Question 19

Investment T/O

Answer 19

Investment T/O = Sales / Average Investment

Question 20

Investment(can equal)

Answer 20

Investment = PP&E + Average total working capital

Question 21

ROE is best used as a……

Answer 21

comparative measure for CY & PY or to compare to different industries

Question 22

Net Income(can equal)

Answer 22

Sales x Return on Sales