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 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.

Change in ROCE due to operating activities = Change in return on net operating assets

Change in ROCE due to Change in Spread = (Debt/Equity) old*((RONAnew-NBCnew)-(RONAOld-NBCOld)

=241/4173*((11.28%-2.9%)-(12.75%-3.22%))

=-0.07%

Change in ROCE due to Change in Leverage = ((Debt/Equity) new - (Debt/Equity)old)*(RONAnew-NBCnew)

=(2225/4756-241/4173)*(11.28%-2.9%)=3.44%

Total Change in ROCE due to Financing Activity = 3.44%-0.07%=3.37%

Else, we can calculate this by using following formula

Change in ROCE due in Financing Activity = (Debt/Equity) new *((RONAnew-NBCNew)- (Debt/Equity)Old

(RONAOld-NBCOld))

=2225/4756*(11.28%-2.9%)-241/4173*(12.75%-3.2%)=3.37%

Change in ROCE due to change in operating activities = (RONA New – RONAOld)=11.28%-12.75%=-1.47%

Total Change in ROCE = -1.47%+3.37%=1.90%

Check Total Change in ROCE = 15.2%-13.3%=1.90%