Case 10

Topics: Balance sheet, Financial ratios, Revenue, Inventory, Operating expense, Asset / Pages: 2 (371 words) / Published: Jan 22nd, 2015
How sensitive is return on capital to the forecast assumptions in case Exhibit 8?
An increase in cash operating expenses decrease NOPAT, which in turn makes ROC extremely sensitive when this ratio goes up; in general when total operating expenses go up NOPAT goes down, thus ROC goes down. In addition if the COGS increase this drastically drops ROC. The total assets has a big impact on ROC an increase of 1000m increased ROC by a full 1.5 percent. The ROC is also very sensitive to the Price to Earnings ratio turnover; yet the receivable-turnover figure has little impact. Inventory turnover is also a factor that affects ROC drastically, a small decrease in inventory turnover drops the ROC drastically as shown below. But most interesting was that sales growth did not have any effect on ROC.
What independent changes in Carrie Galeotafiore’s estimates are required to drive the 2002 return-on-capital estimate below Home Depot’s cost-of-capital estimate of 12.3%?
The ROC can be reduced through a decrease in EBIT of 1,133M, by a decrease in NOPAT of 707M, or an increase in capital of 5,746M. By using the excel goal seek function on exhibit 8 and changing the ROC to 12.3% instead of 15.1% in year 2002E, I found the following results:

ROC = 15.1%
ROC = 12.3%
Gross margin=gross profit/sales
32%
30.2%
Payables/COGS
5%
13.9%
Receivable turnover
55
9.3
Inventory turnover
5.3
3.1
P&E turnover
3.3
2.55
Cash operating exp./sales 21% 22.8%
Income tax rate 37.6% 49.3%

Look specifically at gross margin, cash operating expenses, receivable turnover, inventory turnover, and P&E turnover. What effect does sales growth have on return on capital? Explain your findings.
An increase in sales growth did not have any effect on receivable turnover, inventory turnover, P&E turnover, gross margin, and cash operating expenses. It was also observed that the total sales-growth figure

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