Nonrecourse
debt collateralized
by credit
card receivables
.
LT Unsecured
debt and other borrowings
.
LT Nonrecourse
debt
collateralized
by credit
card receivables
.
Total nonoperating
liabilities
.
Nonoperating
assets
Cash and cash equivalents
.
Shortterm
and longterm
investments
...........................
•
Total nonoperating
assets
.....................................
•
Net nonoperating
obligations
(NNO)
.............................
•
~:Jr1:lingly (drawing on NNE from the income statement and NNO from the balance sheet), we compute the net
• rating expense percent (NNEP) as follows:
.
Net nonoperating expense (NNE)
Net nonoperating expense percent (NNEP)
=
(
)
Average net nonoperating obligations
NN
0
t
nonoperating expense percent (NNEP) measures the average cost of net nonoperating obligations. The
",,"""",,,"w'wator
uses the average NNO similar to the return calculations (such as ROE and RNOA).
ill
(he simple illustration from earlier in this appendix, that company's net nonoperating expense percent is
_:omputed as $35/$500, which is exactly equal to the interest rate on the loan. With real financial statements,
.::p
is more complicated because NNE often includes both interest on borrowed money and nonoperating in
. and NNO is the net of operating liabilities less nonoperating assets. Thus NNEP often reflects an average
on nonoperating activities. For Target, its 2011 NNEP is 3.33%, computed as $477 million/[($14,014 million
...614 million)/2].
Target's 2011 RNOA is ll.43%, which means that net operating assets generate more return than the 3.33%
of
net nonoperating obligations. That is, Target earns a Spread of 8.10%, the difference between RNOA
.'%)
and NNEP (3.33%), on each asset financed with borrowed funds. By borrowing funds, Target creates

ge, which can be measured relative to stockholders' equity; that ratio is called financial leverage (FLEV). In
total nonoperating return is computed by the following formula:
•
Average net nonoperating obligations (NNO)
Nonoperating return
=
x
(RNOA  NNEP)
Average stockholders' equity
~
I
Sptd
I
points are immediately clear from this equation. First, ROE increases with the Spread between RNOA and
~.
The more profitable the return on operating assets, the higher the return to shareholders. Second, the higher
debt relative to equity, the higher the ROE (assuming, of course, a positive Spread).
Target's 2011 Spread between RNOA and NNEP is 8.1O%.lt has average NNO of $14,314 million [($14,014
. n
+
$14,614 million)/2] and average equity of $15,417 million [($15,487 million
+
$15,347 million)/2].
.Target's ROE is as follows:
ROE
=
Operating
return
+
Nonoperating
return
=
11.43%
+
[$14,314/$15,417]
x
[11.43%  3.33%]
=
11.43%
+
[0.9285]
x
[8.10%]
=
18.95%
(0.0001 rounding
error)
companies report both debt and investments on their balance sheets. If that debt markedly exceeds the invest
balance, their ROE will look more like our Target example (with net debt). Instead, if investments predomi
.their ROE will look more like Intel's (with net investments).lt is important to remember that both the average
'0
(and FLEV) and NNE can be either positive (debt) or negative (investments), and it is not always the case
ROE exceeds RNOA.