3 and 3ai ni roe se nopat nne se nopat nne se se noa

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3.3 and 3A.I . NI ROE=- SE NOPAT - NNE SE NOPAT NNE = --- SE SE ( NOA ) (NNO ) = SE X RNOA - SE X NNEP ( SE + NNO ) (NNO ) = SE X RNOA - SE X NNEP [ ( NNO)] (NNO = RNOA X 1 + SE - SE X NNEP ( NNO ) (NNO ) = RNOA + SE X RNOA - SE X NNEP = RNOA + (~~O}RNOA - NNEP) = RNOA + (FLEV X Spread) Special Topics The return on equity (ROE) computation becomes a bit more complicated in the presence of discontinued opera- tions, preferred stock, and minority (or noncontrolling) equity interest. The first of these apportions ROE between operating and nonoperating returns; and the other two affect the dollar amount included in the denominator (aver- age equity) of the ROE computation. Recall that ROE measures the return on investment for common shareholders. TheROE numerator should include only theincome available topay common dividends and theROE denominator should include common equity only, not the equity ofpreferred or minority shareholders. Discontinued Operations Discontinued operations are subsidiaries or business segments that the board of direc- tors has formally decided to divest. Companies must report discontinued operations on a separate line, below income from continuing operations. The separate line item includes the net income or loss from discontinued operations along with any gains or losses on the disposal of discontinued net assets (see Module 5 for details). Although not required, many companies disclose the net assets of discontinued operations on the balance sheet to distinguish them from con- tinuing net assets. If the net assets are not separated on the balance sheet, the footnotes provide details to facilitate a disaggregated analysis. These net assets of discontinued operations should be treated as nonoperating (they represent a nonoperating "investment" once they have been classified as discontinued) and their after-tax profit (loss) should be treated as nonoperating as well. Although the ROE computation is unaffected, the nonoperating portion of the ROE for the year will include the contribution of discontinued operations. Preferred Stock The ROE formula takes the perspective of the common shareholder in that it relates the income available to pay common dividends to the average common shareholder. As such, preferred stock should not be included in average stockholders' equity in the denominator of the ROE formula. Similarly, any dividends paid on preferred stock should be subtracted from net income to yield the profit available to pay common dividends. (Dividends are not an expense in computing net income; thus, net income is available to both preferred and common shareholders. To determine net income available to common shareholders, we must subtract preferred dividends.) Thus, the presence of preferred stock requires two adjustments to the ROE formula. 1. Preferred dividends must be subtracted from net income in the numerator. 2. Preferred stock must be subtracted from stockholders' equity in the denominator.
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