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CHAPTER 8 – RETURN ON INVESTED CAPITAL
Required:
(a) Compute Zear’s return on invested capital for Year 8 where invested capital is: (1) Net operating assets at
end of Year 8 (assume all assets and current liabilities are operating). (2) Common equity capital at end of
Year 8.
(b) Calculate the maximum annual wage increase Zear can pay each plant employee and show a 10% return on
net operating assets.
Problem 8 – Disaggregating and Analyzing Return on Common Equity
Selected financial statement data from Texas Telecom, Inc., for Years 5 and 9 are reproduced below ($ millions):
Year 5 Year 9
Income Statement
Data Revenues........................................ $542 $979
Operating income............................ 35 68
Interest expense.............................. 7 0
Pretax income................................. 28 68
Income taxes................................... 14 34
Net income...................................... 14 34
Required:
(a) Calculate return on common equity and disaggregate ROCE for Years 5 and 9 using end-of-year values for
computations requiring an average (assume fixed assets and working capital are operating and a 50% tax
rate).
(b) Comment on Texas Telecom’s use of financial leverage.
Year 7 Year 6
Sales revenue
Product A............................. $60,000 $35,000
Product B.............................. 30,000 45,000
Total...................................... 90,000 80,000
In Year 6, the selling price of A is $5 per unit, while in Year 7 it is $6 per unit. Product B sells for $50 per unit in both
years. Security analysts and the business press expressed surprise at Johnson’s 12.5% increase in sales and $4,500
decrease in gross margin for Year 7.
Required:
Prepare an analysis statement of the change in gross margin for Year 7 versus Year 6. Discuss and show the effects
of changes in quantities, prices, costs, and product mix on gross margin.
Problem 10 – Common-Size Analysis of Comparative Income Statements
Comparative income statements of Spyres Manufacturing Company for Years 9 and 8 are reproduced below:
Year 9 Year 8
Net sales.................................. $600,000 $500,000
Cost of goods sold.................... 490,000 430,000
Gross margin........................... 110,000 70,000
Operating expenses.................. 101,000 51,000
Income before taxes................. 9,000 19,000
Income taxes............................ 2,400 5,000
Net income............................... $6,600 $ 14,000
Required:
(a) Prepare common size statements showing the percent of each item to net sales for both Year 8 and Year 9.
Include a column reporting the percentage increase or decrease for Year 9 relative to Year 8 (round numbers
to the tenth of 1%).
(b) Interpret the trend shown in your percentage calculations of a. What areas identified from this analysis should
be a matter of managerial concern?