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Analyzing a Change in Return on Common Equity

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Answer: 3.37% due to financing; -0.07% due to change in spread; 3.44% due to change in leverage. Please show work as this is being used as a study guide.

Analyzing a change in Return on Common Equity

The following numbers were calculated from the financial statements for a firm for 2006 and 2005:

2006 2005
Return on common equity (ROCE) 15.2% 13.3%
Return on net operating assets (RNOA) 11.28% 12.75%
Net borrowing cost (NBC) 2.9% 3.2%
Average net financial obligations (millions) 2,225 241
Average common equity (millions 4,756 4,173

Explain how much of the change in ROCE form 2005 to 2006 is due to operating activities and how much is due to financing activities. How much of the change in ROCE form financing activities is due to a change in financial leverage, much is due to a change in the spread over net borrowing costs? Box 12.10 will help you.

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The solution analyzes a change of return on common equity from 2005 to 2006 due to operating activities.

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Answer: 3.37% due to financing; -0.07% due to change in spread; 3.44% due to change in leverage.

Analyzing a change in Return on Common Equity
The following numbers were calculated from the financial statements for a firm for 2006 and 2005:

2006 2005
Return on common equity (ROCE) 15.2% 13.3%
Return on net operating assets (RNOA) 11.28% 12.75%
Net borrowing cost (NBC) 2.9% 3.2%
Average net ...

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