At the end of the fiscal year ending June 30, 2003, Microsoft reported common eq
ID: 2728416 • Letter: A
Question
At the end of the fiscal year ending June 30, 2003, Microsoft reported common equity of S64.9 billion on its balance sheet, with $49.0 billion invested in financial assets (in the form of cash equivalents and short term investments) and no financing debt. For fiscal year 2004, the firm reported $7.4 billion in comprehensive income, of which $1.1 billion was after-tax earnings on the financial assets. This month Microsoft is distributing $34 billion of financial assets to shareholders in the form of a special dividend. Calculate Microsoft's return on common equity (ROCE) for 2004. Holding all else constant what would Microsoft's ROCE be after the payout of $34 billion? Would you expect the payout to increase or decrease earnings growth in the future? Why? What effect would you expect the payout to have on the value of a Microsoft share?Explanation / Answer
a. ROCE = Earnings attributable to equity shareholders / Equity shareholders' funds x 100
= 7.4 Billion / (64.90 Billion + 49.0 Billion) x 100
= 6.50%
b. ROCE = Earnings attributable to equity shareholders / Equity shareholders' funds x 100
= (7.4 Billion - 1.1 Billion)/ 64.90 Billion x 100
= 9.71%
c. The payout will increase the earnings in the future. Since assets were earning a lower rate of return, and this return was distributed among all the shareholders, leading to a reduction in their ROCE.
d. The value of Microsoft share would increase due to increase in the ROCE.
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