Home depots return on equity roe for 2011 was

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Home Depot's return on equity (ROE) for 2011 was 17.4%.4Companies can effectively use debt to increase returns to shareholders. By comparing ROE and RNOA (see graphic below) we can see the power of this leverage. During 2011, Home Depot had a nonoperating return of 4.1% (17.4% - 13.3%) because the company borrowed money at an average, after-tax rate of 4% and invested it in profitable operating activities that earned 13.3%. Financial leverage (FLEV) measures companies' relative use of debt to equity. In 2011, Home Depot's FLEV was 0.45, computed as average FLEV for 2011 and 2010. For 2011, FLEV was 0.48: ($1,042 + $8,707 - $545 - $139)/$18,889; and for 2010, FLEV was 0.42: ($1,020 + $8,662 - $1,421' - $33)/$19,393). This means that for every dollar of equity, the company had $0.45 of net nonoperating obligations (primarily short and long-term debt). The higher the FLEV the greater the nonoperating return. However, as companies' debt increases (higher FLEV) so does the risk of default. Companies like Home Depot balance the benefit of leverage with this increased risk. Ideally, numbers in the RNOA analysis are adjusted to better reflect a company's economic profitability. We exclude items that we expect will not persist to reveal a more accurate picture of the company's future profitability (as well as for liquidity, solvency, and cash flow). All ratios we compute in credit analysis should use these adjusted income statement items as inputs. An examina- tion of Home Depot's income statement and footnotes reveals no material one-time charges. 2009 2010 2011 25% 20% 15% 10% 5% 0% 2008 Coverage Analysis Coverage ratios compare operating profits or cash flows to interest and/or principal payments. We use coverage ratios along with RNOA and ROE, to assess the company's ability to generate profit and cash to cover the fixed charges from debt (interest and principal) in the short and long term. Times interest earned The times interest earned ratio reflects the operating income available to pay interest expense and is defined as follows: Earnings before interest and taxes Tirnesinterestearned = ----~~-------------------- Interest expense The underlying assumption is that only interest must be paid because the principal will be refi- nanced. The numerator is similar to net operating profits after tax (NOPAT), but it is pretax instead of after tax. Management wants this ratio to be sufficiently high so that there is little risk of default. Home Depot's 2011 times interest earned ratio is 10.9 ($5,803 million/$530 million). The ratio was 7.0 in 2010 ($4,699 million/$676 million). The 2011 increase is a result of increased profitability coupled with a drop in interest expense. 4 $3,338 millionl[($19,393 million + $18,889 million)/2]
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Module 4 I Credit Risk Analysis and Interpretation 4-14 ITDA Coverage Ratio ings before interest, tax, depreciation and amortization (EBITDA) is a non-GAAP perfor- ce metric commonly used by analysts and investors. EBITDA coverage is defined as: Earnings before tax + Interest expense, net + Depreciation + Amortization - ITDA coverage = ----==-------------"---------=---------- Interest expense ratio is similar to times interest earned ratio, but more widely used because depreciation does
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