Broward Manufacturing recently reported the following information Net income ROA

Question

Broward Manufacturing recently reported the following information Net income ROA Interest expense Accounts payable and accruals $1,000,000 Broward's tax rate is 30%. Broward finances with only debt and corn on equity, so it has no preferre invested capital is common equity. Calculate its basic earning power BE its return on equity ROE decimal places. BEP ROE ROIC $455,000 10% $159,250 stock. 40% of ts tota invest capital S debt while fit total and s return on in este capital RD Round your answersto o

Explanation / Answer

Net Income = $ 455000 and Return on Assets = (Net Income / Total Assets) x 100 = 10 %

Total Assets = 455000 / 0.1 = $ 4550000

The total invested capital is considered to be the firm's entire common equity and long-term interest-bearing debt. In other words, invested capital excludes short-term liabilities such as accounts payable and accruals. Hence, total firm assets and invested capital differ by the amount of the firm's accounts payable, accruals and other such short-term non-interest bearing liabilities.

Invested Capital = Total Assets - Accounts Payable and Accruals = 4550000 - 1000000 = $ 3550000

Equity Value in Invested Capital = (60/100) x 3550000 = $2130000 and Debt = (3550000 - 2130000) = $ 1420000

Return on Equity = (Net Income / Equity Value) x 100 = (455000 / 2130000) x 100 = 21.36 % approximately.

Tax Rate = 30 %

Profit Before Tax (PBT) = Net Income / (1-Tax Rate) = 455000 / (1-0.3) = $ 650000

ADD: Interest Expense = $ 159250

EBIT (Earnings Before Interest and Taxes) = $ 809250

Basic Earning Power (BEP) = EBIT / Total Assets = 809250 / 4550000 = 0.1779 or 17.79 %

Return on Invested Capital should ideally be calculated by dividing the Net Income with the Total Invested Capital. However, a lot of companies blow up the net income by adding one-time discretionary items such as gains/losses from foreign currency fluctuations, proceeds from a subsidiary sale, etc thereby making the net income an inaccurate measure of return generated by invested capital (which is what the ROIC tries to measure). Hence, a relatively more accurate measure of the ROIC would involve dividing the NOPAT (Net Operating Profit After Taxes) with the total invested capital.

NOPAT = EBIT x (1-Tax Rate) = 809250 x (1-0.3) = $ 566475

ROIC = NOPAT / Total Invested Capital = 566475 / 3550000 = 0.1596 or 15.96 %

NOTE: In case the ROIC solution is shown incorrect then the Net Income / Invested Capital formula is being used which gives ROIC = (455000 / 3550000) = 0.1282 or 12.82 % approximately.

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