Purchase Solution

Utilization of Capital

Not what you're looking for?

Ask Custom Question

A. Describe some of the advantages and disadvantages of ROE as a measure of corporate profitability. What is a typical level of ROE, and how does one know if the ROE reported by a given company reflects an adequate return on investment?

B. Define the profit margin, total asset turnover, and financial leverage factors that contribute to ROE. Discuss the advantages and disadvantages of each of these potential sources of high ROE.
C. Based upon the finding reported in Table 11.3, discuss the relation between P/E ratios and ROE, profit margins, total asset turnover, and financial leverage. In general, which component of ROE is the most useful indicator of the firm's ability to sustain high profit rates in the future?

See attached file for full problem description.

Attachments
Purchase this Solution

Solution Summary

Utilization of Capital is assessed.

Solution Preview

A. Describe some of the advantages and disadvantages of ROE as a measure of corporate profitability. What is a typical level of ROE, and how does one know if the ROE reported by a given company reflects an adequate return on investment?

What Is ROE?
By measuring how much earnings a company can generate from assets, ROE offers a gauge of profit-generating efficiency. The relationship between the company's profit and the investor's return makes ROE a particularly valuable metric to examine.
ROE Calculation
A company's ROE ratio is calculated by dividing the company's net income by its shareholder equity, or book value.
Net Income/Average Common Equity

SIGNAL OF FINANCIAL SUCCESS: Utilization of Capital
ROE offers a useful signal of financial success since it might indicate whether the company is growing profits without pouring new equity capital into the business. It turns out, however, that a company cannot grow earnings faster than its current ROE without raising additional cash. That is, a firm that now has a 15% ROE cannot increase its earnings faster than 15% annually without borrowing funds or selling more shares. But raising funds comes at a cost: servicing additional debt cuts into net income and selling more shares shrinks earnings per share by increasing the total of shares outstanding.

So ROE is, in effect, a speed limit on a firm's growth rate, which is why money managers rely on it to gauge growth potential. In fact, many specify 15% as their minimum acceptable ROE when evaluating ...

Purchase this Solution


Free BrainMass Quizzes
Economics, Basic Concepts, Demand-Supply-Equilibrium

The quiz tests the basic concepts of demand, supply, and equilibrium in a free market.

Pricing Strategies

Discussion about various pricing techniques of profit-seeking firms.

Elementary Microeconomics

This quiz reviews the basic concept of supply and demand analysis.

Economic Issues and Concepts

This quiz provides a review of the basic microeconomic concepts. Students can test their understanding of major economic issues.

Basics of Economics

Quiz will help you to review some basics of microeconomics and macroeconomics which are often not understood.