Lecture notes S2 L 7 - Return on Invested Capital and...

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1 Return on Invested Capital and Profitability Analysis – Subramanyam and Wild, Chapter 8 – Robinson, Greuning, Henry, Broihahn, ch. 7 – Palepu & Healy, Ch. 5 – CFA Program Curriculum, Levels I and II. 1 Key concepts and objectives • Analysis of return on invested capital and profitability involves ratio calculations Ratio analysis determines how various line items in financial statements relate to each other and to measure relative performance. • The key objectives here are as follows: Understand the relevance of return on invested capital in financial statement analysis Understand variations in computing return on invested capital 2
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2 Key concepts and objectives Understand the disaggregation of return on operating assets into various components and its role in financial analysis Understand the disaggregation of return on equity into various components and its role in financial analysis Assess a firm’s success in using financial leverage to improve returns Show how the integrated analysis of return on invested capital can be used to evaluate corporate performance 3 Return on Invested Capital Return on invested capital (ROIC) or Return on Investment (ROI) relates income to a company’s level and sources of financing ROI allows comparisons with alternative investment opportunities Riskier investments expected to yield a higher ROI ROI impacts a company s ability to attract financing, repay creditors,and reward owners 4
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3 Return on Invested Capital Application of ROI Measure of Profitability Measure of managerial effectiveness Measure for planning and control 5 Return on Invested Capital Measuring Profitability ROI is an indicator of company profitability ROI relates key summary measures: income statement (profits) with Balance sheet (financing) to assess profitability ROI conveys return on invested capital from different financing perspectives (Creditors and shareholders) 6
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4 Return on Invested Capital Measuring Managerial Effectiveness Management is responsible for all company activities ROI is a measure of managerial effectiveness in business activities ROI depends on the skill, resourcefulness, ingenuity, and motivation of management 7 Return on Invested Capital Measure for Planning and Control ROI assists managers with: Planning Budgeting Evaluating opportunities Control
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5 Components of ROI Return on invested capital (ROI) is defined as: • Diverse measures of both income and invested capital result in different forms of ROI • When using ROI, make sure you understand what inputs are being used Income Invested Capital 9 Components of ROI Invested Capital Defined – No universal measure of invested capital – Different measures of invested capital reflect different user needs – Common Measures include: Net Operating Assets •Stockholders’ Equity 10
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6 Components of ROI Net operating assets (NOA) Focuses on the company as a whole
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This note was uploaded on 08/27/2011 for the course CORPFIN 7827 taught by Professor Prokim during the Three '11 term at University of Adelaide.

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Lecture notes S2 L 7 - Return on Invested Capital and...

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