- _'. 500 of 7% debt, total assets of $1,500 that earn a 20% return, and a tax rate of 0%. The net income of
is $265, computed
as follows:
$200
Profit from assets financed
with equity
($1,000
x
20%)
.
Profit from assets financed
with debt
($500
x
20%)
.
Less interest
expense
from debt ($500
x
7%)
.
Net profit.
.
$100
(35)
65
$265
company's
ROE is 26.5%,
computed
as $265/$1,000
(assuming
income
received
at year-end
for simplicity
_ ..•.rerage equity is $1,000).
Its RNOA is 20%, FLEV is 0.50 (computed
as $500 of average
net nonoperating
_.
- ns
divided by $1,000 average equity),
and its Spread is 13% (computed
as 20% less 7%). This company's
shown with the nonoperating
return being directly
computed,
is as follows:
ROE
=
RNOA
+
[FLEV
x
Spread]
=
20%
+
[0.50
x
13%
]
=
26.5%
that when a company's
nonoperating
activities
relate solely to the borrowing
of money (without
nonoperat-
ts), FLEV collapses
to the ratio of debt to equity, called the debt-to-equity
ratio.
~"""operating
Return-Without Debt Financing, but
Nonoperating Assets
companies,
such as many high-tech
firms, have no debt, and maintain
large portfolios
of marketable
securi-
They hold these highly liquid assets so that they can respond
quickly
to new opportunities
or react to com-
- re pressures.
With high levels of nonoperating
assets and no nonoperating
liabilities,
the net nonoperating
.:
ions (NNO) has a negative
sign (NNO
=
Nonoperating
liabilities
- Nonoperating
assets). Likewise,
FLEV
_
ive: Average
NNO (-)
/ Average
Equity
(+).
Further,
net nonoperating
expense
(NNE
=
NOPAT -
Net
) is negative because investment
income
is a negative
nonoperating
expense.
However,
the net nonoperating
percent (NNEP)
is positive
because
the negative
NNE is divided by the negative
NNO.
This causes ROE
lessthanRNOA
(see computations
below). We use the 2010 lO-K ofIntel
to illustrate
this curious result (Intel
no noncontrolling
interest).
($
millions,
except
percentages)
2009
Average
Computation
2010
$ 28,652
$(20,778)
$ 49,430
$11,464
$ 11,250
$
(214)
(0.3648)
38.87%
1.29%
37.58%
$ 29,232
$(12,472)
$41,704
$ 28,942
$(16,625)
$ 45,567
A
.............................
•...
0
.
ockholders'
equity
.
et income
.
OPAT
.
NE ( NOPAT -
Net income)
.
REV
.
OA
.......................
•
........
EP
.
Spread
.
$(16,625)/$45,567
$11,2501$28,942
$(214)/$(16,625)
38.87%-1.29%
~rs
NNO is negative
because
its investment
in marketable
securities
exceeds
its debt. Intel's
ROE is 25.16%,
it consists
of the following:
ROE
=
RNOA
+ [
FLEV
X
Spread
=
38.87%
+ [
-0.3648
x
37.58%
=
38.87%
+
[-13.71 %]
=
25.16%