· First Investments Inc. owned stock of Basic Industries (BI), a diversified multinational corporation with major shares in various electrical related markets · The BI annual report of 1994 shows a decline in the return on owners’ equity (ROE) · Fred Aldrich, a trainee in First Investment, was asked to conduct a financial analysis on BI · Three years financial statements (1994, 1993 and 1985) and reported 10 year financial highlights (1985 to 1994) were available for the analysis assignment · The focus was on the 1993-1994 period and comparison of the quality of the returns on equity of 1985 and 1994, along with the other key financial ratios · The analysis should not focus on the financial information of 1989 and 1990 because of a strike. The company did not change its accounting policies and practices materially over the last decade
1. How Basic Industries had achieved its return on equity over the last 10 years ? 2. Why did the ROE of BI decline in 1994 ?
The portfolio people were worried about the decline in owner’s equity. By doing the financial analysis, we hope to find out why the return on shareholders’ equity declined in 1994.
Return on Equity (ROE) = Net Income / Average Stockholder's Equity 17.19% (94)18.12% (93)18.01% (92)17.62% (91)13.19% (90) 11.51% (89)15.39% (88)16.53% (87)16.00% (86)18.00% (85)
ROE in 1994 dropped by almost 1% and was the main cause of concern. This is primarily because the proportion of Capital Employed has increased more than the proportion of Net Profit After Tax. The level of return on invested capital depends primarily on the skill, resourcefulness, ingenuity and motivation of management. In order to analyze the company’s financial performance, we make use of financial ratios. This is done for the period 1985-1994 where possible, and the total analysis can be found in the attached excel spreadsheet. Leverage Ratios
As the leverage ratio increases...