Home Work

Topics: Financial ratios, Debt, Rate of return Pages: 4 (806 words) Published: August 17, 2010
Home Work

1. In 2005 IBM had a return on equity of 26.7 percent, whereas Hewlett-Packard’s return was only 6.4 percent. Use the decomposed ROI framework to provide possible reasons for this difference based on the data below:

IBM HP
NOPAT/Sales 9.0% 2.7%
Sales/Net Assets 2.16 2.73
Effective After-Tax Interest Rate 2.4% 1.1%
Net Financial Leverage 0.42 -0.16

Answer:

IBM Analysis

Return on Operation Asset = NOPAT/sales * Sales/net assets
= 9.00%* 2.16
=19.44%

Borrowing multiplier = ROA- EATR
=19.44%-2.40%
=17.04%

Return on Leverage = Borrowing multiplier * Net Financial leverage
=17.04%*0.42
= 7.15%
ROE = ROA* Net Financial Leverage
26.7% = X*0.42
X=63.57
ROA = 63.57%

Decompose the return on assets:

ROA = Net income/Sales * Sales/Assets
63.57 = X * 2.16
Net income/Sales=29.43%

Hewlett Packard Analysis

Return on Operation Asset = NOPAT/sales * Sales/net assets
=2.70%* 2.70
=7.37%

Borrowing multiplier = ROA- EATR
=7.37%-1.10%
=6.27%

Return on Leverage = Borrowing multiplier * Net Financial leverage
=6.2 %*(0.16)
= -1.%

ROE = ROA* Net Financial Leverage
6.40% = X*(0.16)
X=-40%
ROA = -40%

Decompose the return on assets:

ROA = Net income/Sales * Sales/Assets
-.40 = X * 2.73
Net income/Sales=-14.65%

From the onset, it appears IBM’s 26.7% return on equity indicate that its managers are generating more return for its shareholders than HP that have 6.4 percent return on equity.

In other to access the decomposed ROI framework above to provide the difference based on data of IBM and Hewlett Packard, we will need to assess certain drivers such as Return on Equity/ Return on Asset which helps to measures a corporation's profitability by revealing how much profit a company generates with the...
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