CORPORATE PROFITABILITY:

RETURN ON EQUITY, RETURN ON INVESTMENT,

MODIGLIANI & MILLER PROPOSITION II
AND ECONOMIC VALUE ADDED
Prof. Roberto Moro Visconti – Università Cattolica del Sacro Cuore, Milano ITALY

Dept. of Business Administration – roberto.moro@unicatt.it

Abstract
Corporate profitability is a core issue of financial statement analysis and corporate finance.
Economic profitability, deriving from positive marginality where revenues exceed costs, is
considered in complementary ways.
Return on equity (ROE), Return on investment (ROI), Return on sales (ROS), and other
ratios are systematically illustrated.
This analysis is preparatory to Modigliani & Miller proposition II: as the proportion of
debt in the company's capital structure increases, its ROE increases in a linear fashion. An
empirical case is provided, starting from a real balance sheet.
Economic Value Added represents the value created over the required return of
the company's shareholders, i.e. the net profit less the equity cost of the firm's capital.

Keywords: leverage; profitability; WACC; cost of debt; cost of equity; ROE; ROI.

1. Return on Equity, Return on Investment, and other profitability ratios 1

In corporate finance, the return on equity (ROE) is a measure of the profitability of a business
concerning the book value of shareholder equity, also known as net assets or assets minus liabilities.
ROE is a measure of how well a company uses investments to generate earnings growth.
ROE is equal to net income (Rn), divided by mean total equity [E=(E0+E1)/2], expressed as a
percentage:

=
0+ 1
2

ROE is always positive unless the net return is negative or corresponds to zero.
ROE is especially used for comparing the performance of companies in the same industry. As
with return on capital, ROE is a measure of management's ability to generate income from the equity
available to it.
ROE is also a factor in stock valuation, in association with other financial ratios. In general, stock
prices are influenced by earnings per share (EPS), so the stock of a company with a 20% ROE will
generally cost twice as much as one with a 10% ROE.
The benefit of low ROEs comes from reinvesting earnings to aid company growth. The benefit can
also come as a dividend on common shares or as a combination of dividends and company
reinvestment. ROE is less relevant if earnings are not reinvested.
The DuPont formula, also known as the strategic profit model, is a common way to break down ROE
into three important components. Essentially, ROE will equal the net profit margin multiplied
by asset turnover multiplied by financial leverage. Splitting return on equity into three parts makes it
easier to understand changes in ROE over time. For example, if the net margin increases, every sale
brings in more money, resulting in a higher overall ROE. Similarly, if the asset turnover increases,
the firm generates more sales for every unit of assets owned, again resulting in a higher overall ROE.
Finally, increasing financial leverage means that the firm uses more debt financing relative
to equity financing. Interest payments to creditors are tax deductible, but dividend payments to
shareholders are not. Thus, a higher proportion of debt in the firm's capital structure leads to higher
ROE.
Financial leverage benefits diminish as the risk of defaulting on interest payments increases. So if the
firm takes on too much debt, the cost of debt rises as creditors demand a higher risk premium, and
ROE decreases. Increased debt will make a positive contribution to a firm's ROE only if the
matching return on assets (ROA) of that debt exceeds the interest rate on the debt.
***
Return on Investment (ROI) is the ratio between the net profit and cost of investment resulting from
an investment of some resource. A high ROI means the investment's gains compare favorably to its
cost. As a performance measure, ROI is used to evaluate the efficiency of an investment or to compare
the efficiencies of several different investments. In purely economic terms, it is one way of
relating profits to capital invested.
In business, the purpose of the return on investment (ROI) metric is to measure, per period, rates of
return on money invested in an economic entity to decide whether to undertake an investment. It is
also used as an indicator to compare different investments within a portfolio. The investment with the 2
largest ROI is usually prioritized, even though the spread of ROI over the time period of an investment
should also be considered.
The DuPont formula is the following:

= =

Another formulation is this:

Figure 1 – DuPont Formulation

ROS

ROI
rotation of
invested capital
ROE

debt ratio
ratio of
extraordinary
revenues and costs
Since: net result = retained earning + dividends, ROE can be split:

= +

ROE can also be linked to stock market ratios, multiplying the Price/book value by the earnings yield:
= ∗

And then: E = BV (equity = book value of equity). Rn/P represents the earnings yield or, reciprocally,
the P/E ratio: P/E = P/Rn (where Rn=E = net profit).
The price-earnings ratio (P/E ratio) is the ratio for valuing a company that measures its current share
price relative to its per-share earnings.
The price-earnings ratio indicates the € amount an investor can expect to invest in a company to
receive one € of that company’s earnings. Therefore, the P/E is sometimes referred to as the price
multiple because it shows how much investors are willing to pay per € of earnings. If a company was
currently trading at a multiple (P/E) of 20, the interpretation is that an investor is willing to pay €20
for €1 of current earnings.
Return on Investment (ROI) is a ratio that represents the profitability of the invested capital, i.e. the
ratio between the operating profit (EBIT), and the average invested capital of the period. The formula
is the following:
3
=

Return on assets (ROA) is an indicator of how profitable a company is relative to its total assets. ROA
gives a manager, investor, or analyst an idea of how efficient a company's management is at using its
assets to generate earnings. Return on assets is displayed as a percentage and it is calculated as:

ROA = Net Income / Total Assets

Sometimes, the ROA is referred to as "return on investment", if total assets = invested capital = raised
capital. ROA tells us how efficiently a business uses its existing assets to generate profits. ROIC tells
us how effective a business is in re-investing in itself. Return on Assets is simply the profit that all
the business assets generate each year. The higher the percentage, the more efficient your assets are.
Traditionally, the formula for ROA is simply Net Income ÷ Total Net Assets (Total Net Assets are
Total Assets after depreciation). Return on Assets is often driven by the capital intensity of the
business. The greater the fixed assets required to operate the business, the lower the ROA tends to be
for companies in that industry.

2. Invested Capital

The invested capital corresponds to the raised capital (uses = sources). Raised capital is given by: net
equity + financial debts (short-term + long-term).
Financial debts correspond to Net Financial Position if liquidity and financial credits are equal to
zero. Net Financial Position is financial liabilities minus cash and cash equivalents. Net financial
position may be negative, in which case it is referred to as net debt.
Invested capital also corresponds to Net fixed assets + net working capital – leaving indemnity and
other provisions + net financial assets.

Figure 2 – Total Assets, Invested Capital, Total Liabilities, and Raised Capital

3. Relationships between ROI and ROE

Return on sales (ROS) is a ratio used to evaluate a company's operational efficiency; ROS is also
known as a firm's operating profit margin.
This measure provides insight into how much profit is being produced per € of sales. An increasing
ROS indicates that a company is growing more efficiently, while a decreasing ROS could signal
looming financial troubles.
ROS measures the performance of a company by analyzing the percentage of total revenue that is
converted into operating profits.
ROS expresses the profitability of sales:

The relationship between ROS, ROE, and ROI is the following:

 = =

And so:
= =

We also have:

• Make some accounting examples showing how ratios change. The target is ROE maximization,
increasing some key variables (e.g., increasing sales, keeping the invested capital unchanged) and
showing the impact on the other variables.

ROE can be represented as a sub-sample of ROI, considering the following (simplified) balance sheet:

Figure 3 – The Link between the Income Statement and the Balance Sheet

Operating
Net Operating revenues 5
Working Financial
Capital Debts - operating costs
(and taxes) = EBITDA
- depreciation
Net =EBIT 100
Fixed
Assets - negative interests (25)
equity - taxes (5)

= net income 70
Invested Raised
capital capital

We know that: net result + taxes + negative interests = EBIT. And so:

+ +
= =
+

The yellow part corresponds to ROE which is so a sub-sample of ROI. The other part expresses the
cost of debt and taxes.
4. Modigliani & Miller proposition II

The Modigliani–Miller theorem (1958)1 is a theorem on capital structure, arguably forming the
basis for modern thinking on corporate finance. The basic theorem states that in the absence
of taxes, bankruptcy costs, agency costs, asymmetric information, and an efficient market, the value
of a firm is unaffected by how that firm is financed. Since the value of the firm depends neither on
its dividend policy nor its decision to raise capital by issuing stock or selling debt, the Modigliani–
Miller theorem is often called the capital structure irrelevance principle.
The key Modigliani-Miller theorem was developed in a world without taxes. However, if we move
to a world where there are taxes when the interest on debt is tax-deductible, and ignoring other
frictions, the value of the company increases in proportion to the amount of debt used. And the source
of additional value is the amount of taxes saved by issuing debt instead of equity.
Consider two firms that are identical except for their financial structure. The first (Firm U)
is unlevered: that is, it is financed by equity only. The other (Firm L) is levered: it is financed partly
by equity, and partly by debt. The Modigliani–Miller theorem states that the value of the two firms is
the same.

Proposition I M&M (With taxes)

= +
where:
• VU is the value of an unlevered firm = price of buying a firm composed only of equity, 6
• VL is the value of a levered firm = price of buying a firm that is composed of some mix of
debt and equity.
• = tax rate * (market) value of debt
Another word for levered is geared, which has the same meaning.
To see why this should be true, suppose an investor is considering buying one of the two firms, U or
L. Instead of purchasing the shares of the levered firm L, he could purchase the shares of firm U and
borrow the same amount of money B that firm L does. The eventual returns to either of these
investments would be the same. Therefore, the price of L must be the same as the price of U minus
the money borrowed B, which is the value of L's debt.
This discussion also clarifies the role of some of the theorem's assumptions. We have implicitly
assumed that the investor's cost of borrowing money is the same as that of the firm, which need not
be true in the presence of asymmetric information, in the absence of efficient markets, or if the
investor has a different risk profile than the firm.

1 Modigliani, Miller (1958).

Figure 4 – MM Proposition II (Ko= WACC= constant; Ke≈ROE; Kd=cost of debt)

Proposition II

Proposition II with risky debt states that as leverage (D/E) increases, the WACC (k0) remains
constant.
The formula is the following:

= + −

7
Where:
EBIT / invested capital = ROI
Negative interests / financial debt = i = ki = cost of debt
Financial debt / equity = (financial) leverage = d
Adjusted pre-tax profit = net profit, before taxes, extraordinary items and positive interests = Rn/Rn*

And so:

= + − ∗

MM II deals with the WACC. It says that as the proportion of debt in the company's capital structure
increases, its return on equity to shareholders increases in a linear fashion.
A higher debt-to-equity ratio leads to a higher required return on equity, because of the higher risk
involved for equity-holders in a company with debt. The formula is derived from the theory
of weighted average cost of capital (WACC).
These propositions are true under the following assumptions:

• no transaction costs exist, and

• individuals and corporations borrow at the same rates.

These results might seem irrelevant (after all, none of the conditions are met in the real world), but
the theorem is still taught and studied because it tells something very important. That is, capital
structure matters precisely because one or more of these assumptions is violated. It tells where to look
for determinants of optimal capital structure and how those factors might affect optimal capital
structure.
• Students are asked to show, even with accounting examples using Excel, which the logic links
between the components of (ROI-i)* d. It should be pointed out what happens if d grows, the
company has more raised (=invested) capital and is unable to proportionally increase EBIT.

The difference (ROI-I) expresses the gap between the return on invested capital and the cost of debt:
ROI (compare to WACC, in market terms) shows the return of the investment whereas i corresponds
to the cost of debt. To understand the convenience of the investment, we have to consider the
following cases:

1) ROI > i so (ROI - i) > 0

2) ROI = i so (ROI - i) = 0
3) ROI < i so (ROI - i) < 0

return on debt (i = negative interests / financial debt) represents the "ROI of debt-holders”.
The debt ratio – d- operates as a “leverage” on the differential (ROI - i).
Even for d there are three possible cases:

1) d = 0 when financial debts correspond to zero in an unlevered firm (with no debt). If so,
equity corresponds to the raised capital (=invested capital), and profitability of equity =
8
profitability of raised/invested capital. So, ROE = ROI2.
2) d > 1 when financial debts > equity. This hypothesis is very frequent, especially for under-
capitalized companies. In this case, d acts as a multiplier of the difference (ROI – i).
3) d < 1 when financial debts < equity, and leverage (d) acts as a de-multiplier.

When the difference (ROI-i) is positive, there may be a temptation to increase, even substantially, the
leverage (raising debt and keeping the equity unchanged or decreasing the equity by paying dividends
…). When leverage (d) is increased, the denominator of the cost of debt (i= negative interests /
financial debt) grows but if debt trespasses manageable levels then the cost of debt grows,
incorporating higher bankruptcy costs and a worse rating that require a higher risk premium (see also
the adverse selection issue in Stiglitz, Weiss, 1981).
Any increase in the leverage has an impact on ROI: the denominator of ROI (EBIT/invested=raised
capital) grows since debt is a component of raised capital. Any leverage increase normally bears an
increase of raised capital (if equity is unchanged). The company has more sources of funds that are
translated into more uses in the invested capital (CAPEX, stock, credits …).
What happens if any increase of invested=raised capital (that is part of the ROI denominator) does
not bring a proportional increase of EBIT (the numerator of ROI)? If it is so, ROI decreases and so
does the differential (ROI-i) which can even become negative. And if (ROI-i) becomes negative, the
situation can be complicated, since leverage has substantially grown. There is so a dangerous
boomerang effect.

2 if d = 0, the equation (M&M – II) becomes ROE = ROI. Since invested capital = Equity and EBIT = net profit, then
ROE = ROI.
Considering an increase in financial debts and invariant equity, we have:

+ = ↑
−
= ↑+ ≅ ↑ ≅

But any increase in financial debts bears an increase (at least proportional) of negative interests. If
equity is unchanged, then higher debt brings higher invested=raised capital and this should increase
both the revenues and the operating/net economic marginality, with a positive impact on EBIT and
net profit. If this virtuous process is blocked, then wealth is diluted, since we need more capital to get
the same economic results. And so, considering an uncertain change in net profit (net profit?), we
have:

?+ ↑= ↑ ↑
−
. = ↑+ ≅ ↑ ≅

Beyond a confidence threshold, negative interests increase more than proportionally, and the (ROI-i)
differential shrinks:

?+ ↑↑= ↑↑ ↑
−
. = ↑+ ≅ ↑ ≅

These consequential effects can be understood with a reinterpretation of Figure 3

9

Figure 5 – The Impact of a Leverage Increase on the Market Value and Book Value of the Invested
Capital

(ROI-i) levered by Financial debt / equity.

Implicit Is there real value creation?
Goodwill (?)
Working
Operating
Net Operating revenues
Working Financial
Capital Debts - operating costs
(and taxes) = EBITDA
- depreciation
Net =EBIT 100
Fixed
Assets - negative interests (25)
equity - taxes (5)

= net income 70
Invested Raised
capital capital

Example 1 shows the possible combinations of ROI, i, and d, remembering that if ROI = i and/or d=0,
then (ROI-i)*d=0.
 ROI i (ROI - i) d (ROI - i)*d
a) 15 % 12 % 3% 1,5 4,5 %
b) 15 % 12 % 3% 0,5 1,5 %
c) 15 % 20 % -5% 1,5 -7,5 %
d) 15 % 20 % -5% 0,5 -2,5 %

As it is shown, when the difference (ROI-i) is positive, high leverage is convenient, to increase the
leverage effect. Considering case a), increasing the value of d, there is a consequent (exponential)
growth in the value of (ROI-i)*d.
In economic terms, when investments have profitability that exceeds the cost of their financing, it is
convenient to get into debt.
This reasoning is however simplistic and does not consider the collateral effects of excessive debt.
Banks and other financial lenders typically apply a variable spread to Euribor (or other Interbank
rates). An example is given in the following table (where interest rates are expressed in basis points;
1 basis point = 0.01%).

A company
financially Company in Companies close
close to
Parameter sound financial to insolvency or
financial
company equilibrium bankruptcy
disequilibrium
10
Debt / equity (D/E) D/E < 2 2 < D/E < 2,5 2,5 < D/E < 3,25 > 3,25
[financial leverage]

EBITDA / net negative E/OF > 5 4 < E/OF < 5 3 < E/OF < 4 <3
interests (E/OFN)

Withdrawal of the
Spread + 175 + 200 + 225 financing

• The debt/equity ratio corresponds to the financial leverage;

• The ratio EBITDA / net negative interests link EBITDA (i.e., the economic or financial
margins deriving from the current business activity) to net negative interests that are
consequent to a negative Net Financial Position.

• Consider an accounting example, imported from the Excel spreadsheet, where a complete
balance sheet and profit & loss account (income statement) is reported, linking the two
concepts. In the first part of the example, try to develop an increase of the leverage (from < 2,
then in the interval from 2 and 2.5 and so on, following the example) and an increase of the
ratio EBITDA / negative interests (E/Of), linking the two concepts. For example, if E/Of is
good (>5), is it convenient to use the cash flow created from the income statement (i.e.,
EBITDA) to reimburse debts and reduce the leverage? This depends also on the differential
(ROI-i) …

Considering ROE as a function of d (financial leverage), we can have the following representation:
 ROI > i
ROE

ROI

i
(%)
ROI = i

d (>1)

ROI < i

ROE is a function of ROI and leverage: the profitability grows and reaches a peak when ROE is still
positive but no greater than the cost of debt (ROE ≤ i).
Beyond the breakeven point (ROE = 0), the equity decreases.
According to the formulation of Modigliani & Miller (proposition II), ROE increases linearly as a
function of leverage, provided that the cost of debt (i) remains constant. When i > ROI, ROE collapses
and may soon become negative.

Consider the following example. 11

Example 2 – Impact of a leverage (d) increase on the cost of debt (i) and ROE

ROI d i ROE
15 % 0,5 12 % 16,5 %
15 % 1 12 % 18,0 %
15 % 1,5 12 % 19,5 %
15 % 2 12 % 21 %
15 % 2,5 13 % 20 %
15 % 2,8 14 % 17,8 %
15 % 3 15 % 15 %
15 % 3,5 17 % 8%
15 % 4 20 % -5 %
Figure 6 – Impact of an increase in financial leverage (d) on the cost of debt (i) and ROE

ROI
ROE
i
19 d

14

-1

-6

6. From Economic Value Added (EVA) to Market Value Added (MVA)

12
Economic value added ® (EVA) is an estimate of a firm's economic profit or the value created over
the required return of the company's shareholders. EVA is the net profit less the equity cost of the
firm's capital. The idea is that value is created when the return on the firm's economic capital
employed exceeds the cost of that capital.
EVA is a measure of the extra profit generated by the company.
EVA is net operating profit after taxes (or NOPAT, similar to EBIT less taxes) less a capital charge,
the latter being the product of the weighted average cost of capital (WACC) and the Invested capital.
The basic formula is:

EVA = NOPAT - WACC * Ci

Or :

EVA = (r – WACC) * Ci
Where:

• EVA = Economic Value Added

• NOPAT = Net Operating Profit After Taxes
• WACC = Weighted Average Cost of Capital
• Ci = Invested Capital (Equity + financial debts + provisions)
• r = NOPAT/Ci = capital return (adjusted ROI)
NOPAT is the profit derived from a company’s operations (a sort of EBIT) after cash taxes but before
financing costs and non-monetary revenues and costs. It represents the total pool of profits available
to provide a cash return to those who provide capital to the firm. Invested capital is the amount of
cash invested in the business, net of depreciation. It can be calculated as the sum of interest-bearing
debt and equity or as the sum of net assets less non-interest-bearing current liabilities.
The capital charge is the cash flow required to compensate investors for the riskiness of the business
given the amount of economic capital invested. The cost of capital is the (minimum) rate of return on
capital required to compensate investors (debt and equity) for bearing risk. Here we consider the
Weighted Average Cost of Capital (WACC). Being EVA expressed in terms of WACC, it is
independent of the financial structure (unless the latter doesn’t have an impact on the WACC) and it
doesn’t discriminate between levered and unlevered firms.
EVA improvements are consistent with the target of maximizing the market value of a company.
According to EVA:
• a company generates added value (EVA>0) generates added value (EVA>0) if the capital
return (r) is higher than the weighted average cost of capital (WACC);
• burns added value in the opposite case (r<WACC).
The original EVA method considers some adjustments to the NOPAT and invested capital values, to
express a fair measure of the capital invested by the debtholders and of the available monetary profit.

Invested capital integrations

accounting invested capital
+ reserves for deferred taxes
13
+ LIFO reserve
+ goodwill amortizations
+ net intangibles costs
+ reserves for future expenses
+ net extraordinary incomes and expenses
+ generic risk founds
= Adjusted invested capital

Operating profit adjustments

net operating profit
+ provisions for deferred taxes
+ variation of LIFO reserve
+ goodwill amortization
+ cost to be capitalized
+ provision for future expenses
- taxes saved on financial charges
+ generic risk provisions
= NOPAT
In the NOPAT calculation, accounting adjustments are carried out considering the accrual basis
accounting instead of a cash basis, according to the financial method of firm evaluation. For example:
 • the taxes attributable to the operating profit are those effectively due;
• losses on receivables are attributable to the financial year in which they are definitively
ascertained and not to those in which the revenue is achieved;
• intangible costs are amortizable in 5 years;
• the goodwill should be not amortized.

The cycle: Sources  Funds 

operating NOPAT  financial NOPAT

operating    Investors
NOPAT COMMERCIAL NET
WORKING CAPITAL

FIXED
ASSETS SHARE
financial
CAPITAL
NOPAT

 Funds acquisition of capital and debt (raised capital)
14
 Funds investment in net working capital and fixed assets (invested capital)
 Generation of operating NOPAT (funds applications in net working capital and fixed assets 
sales  operating NOPAT)
 Operating NOPAT generates operating cash flows for investors (debtholders and shareholders)
The Market Value Added (MVA) consists of Text
the difference between the market value and the
accounting invested capital:

MVA = market value – invested capital = present value of the

expected EVA = EVA / (WACC – g)
Where g is a (sustainable) growth rate.
MVA could also represent a measure of the extra value (goodwill) generated by a company compared
to the bound resources.
Considering that EVA is positive when r > WACC, a company has an MVA > 0 when is expected
that r / WACC > 1.
intin other words if we have a
capital return more tham wacc
we have a marhet value
positive, so ROI discounted in
WACC is more than 1
 we crete and destroy value with thw same formula, eva/wacc-g
burn value+Mv=invested capital
mv= invested capital plus value created

In efficient markets, companies with EVA and MVA > 0 should have growing stock prices and
improving credit rating, reducing the market risk premium and consequently the cost of capital and 15
the WACC, increasing the difference r-WACC (growing EVA) and decreasing WACC-g
(heightening MVA).

7. From ROI to WACC

The weighted average cost of capital (WACC) is a calculation of a firm's cost of capital in which each
category of capital is proportionately weighted.
WACC is the weighted average of the different funding sources of the firm: cost of equity, cost of
debt, and, sometimes, the cost of preferred equity.

WACC=E/(D+E)∗Ke + D/(D+E)∗Kd∗(1−Tc)
where:
Ke = Cost of equity
Kd = Cost of debt
E = Market value of the firm’s equity
D = Market value of the firm’s debt
Tc = Corporate tax rate

The weighted average is calculated by multiplying the cost of equity and the cost of debt, by their
respective weight in the capital structure (sources of funds):
• E/(D+E) indicates the % of equity (E)
• D/(D+E) indicates the % of the debt (D)
• both D and E are reported at market values (not at book value) since the cost of capital
measures the cost of issuing equity and debt in the market, to back investments.
The firm creates value whenever ROIC > WACC, i.e., when the invested capital yields a return ROI
(ROIC) that is higher than the (market) cost of collecting capital:

Implicit goodwill /
intangible-driven ROIC > WACC
goodwill

R Fixed equity
O Assets
I
C Net WACC
Current Financial
Assets Position
16

Invested capital = raised capital

8. A practical case of corporate profitability analysis (M&M II)

A practical case of corporate profitability analysis starts from a balance sheet and income statement
and then calculates the profitability equation, step by step.

Delta – Balance sheet 2015 and 2016 (Asset & Liabilities; Profit & Loss account)

17
 Balance sheet contents ex art. 2424 c.c. (in euro) - ASSETS 31/12/2015 31/12/2016

B) Fixed assets
I. Intangible fixed assets:
2) Research, development and advertising costs 3.400
3) Industrial patent rights and exploitation rights in creative
works
4) Concessions, licenses, trade marks and similar rights 210.221 186.007
5) Goodwill 116.000
7) Other 492.709 606.397

Total 702.930 911.804

II. Tangible fixed assets:

1) Land and buildings 2.925 2.338
2) Plants and machinery 5.678 54.174
3) Industrial and commercial fixtures 55.086 90.041
4) Other fixtures 170.839 311.194

Total 234.528 457.747

III. Financial assets:

1) Shares in:
d-bis) other companies 775 775
775 775

Total 775 775

Total fixed assets (B) 938.233 1.370.326

C) Current assets
I. Stocks:
1) Raw and ancillary materials and consumables 24.700 21.135
4) Finished products and goods 3.239.383 4.757.804
18
Total 3.264.083 4.778.939

II. Receivables:
1) From trade debtors
- within 12 months 13.203.472 10.176.155
- over 12 months
13.203.472 10.176.155
5-bis) From tax authorities
- within 12 months 85.177 141.562
- over 12 months
85.177 141.562
5-ter) For advance tax payment
- within 12 months 11.866 4.247
- over 12 months 16.880
11.866 21.127
5-quater) From others
- within 12 months 274.962 398.955
- over 12 months
274.962 398.955

Total 13.575.477 10.737.799

IV.Cash availability:
1) Bank and postal deposit 18.171 767.579
2) Cheques 20.721 20.851
3) Money and cash values 15.773 14.355

Total 54.665 802.785

Totale current assets (C) 16.894.225 16.319.523

D) Prepayments and accrued income 56.015 275.391

Total assets 17.888.473 17.965.240

 Balance sheet contents ex art. 2424 c.c. (in euro) - LIABILITIES 31/12/2015 31/12/2016

A) Capital and reserves

I. Subscribed capital 103.480 103.480
IV. Legal reserve 21.426 21.426
V. Statutory reserve
VI. Other reserve
- reserve for dividend unpaid 49.053
- conversion / rounding reserve - 1
- optional reserves 651.319 1.000.780
VII. Reserve for financial hedging operations
VIII. Profit (loss) brought forward
IX. Profit (loss) for the financial year 300.409 80.680
X. Negative reserve for own shares

Total 1.125.687 1.206.365

B) Funds for liabilities and charges

1) For pensions and similar obligations 26.742 45.275

2) For taxes, even deferred 2.160

Total 26.742 47.435

C) Severance indemnity for employees 234.990 318.937

D) Debts

3) Amounts owed to shareholders for loans

- within 12 months 470.839
- over 12 months
- 470.839
4) Amounts owed to banks
19
- within 12 months 6.096.839 7.971.600
- over 12 months 520.000 1.960.519
6.616.839 9.932.119
5) Amounts owed to other financiers
- within 12 months 532.055 1.113.592
- over 12 months 8.442
532.055 1.122.034
6) Payments on account
- within 12 months 606.837
- over 12 months
606.837 -
7) Amounts owed to trade creditors
- within 12 months 7.373.360 3.740.419
- over 12 months
7.373.360 3.740.419
12) Amounts owed as taxes
- within 12 months 95.715 200.792
- over 12 months
95.715 200.792
13) Amounts owed to social security institutions
- within 12 months 91.089 130.196
- over 12 months
91.089 130.196
14) Other debts
- within 12 months 975.139 429.257
- over 12 months 1.500 1.500
976.639 430.757

Total 16.292.534 16.027.156

E) Accrual and deferred income 208.520 365.347

Total liabilities 17.888.473 17.965.240

 Profit and loss account (Income Statement)
2016
ex art. 2425 c.c. (in euro)

A) Value of production

1) Revenues from sales and services 22.822.493

5) Other incomes and earnings:
a) Different revenues and incomes 122.456
b) Contributions related to the financial year
c) Sundry 500.188

Total 23.445.137

B) Costs of production
6) Raw and ancillary materials and consumables 14.194.538
7) Services 5.417.179
8) Utilisation of assets belonging to third parties 901.789
9) Staff:
a) wages and salaries 1.805.356
b) social security costs 574.601
c) severance indemnity for employees 141.112
d) pensions and similar obligations
e) other costs
2.521.069
10) Depreciations and devaluations:
a) amortisation of intangible fixed assets 222.402
b) depreciation of tangible fixed assets 87.357
c) other devaluations of fixed assets
d) devaluation of credits included in current and liquid
assets 50.776
360.535
11) Variations in stocks of raw and ancillary materials,
consumables and goods -1.514.856
12) Provisions for risks
20
13) Other provisions
14) Sundry operating charges 458.818
- other 1

Total 22.339.073

Balance between value of production and costs (A-B) 1.106.064

C) Income and financial charges

16) Other financial incomes:
d) incomes other than the foregoing:
- other 4.878
4.878

4.878

17) Interests and other financial charges:

- other -518.277
-518.277

17-bis) Profits and losses on currency exchange -295.993

Total (15 + 16 - 17 + - 17 bis) -809.392

Pre-tax result (A-B+-C+-D) 296.672

20) Taxes of the financial year:

- current 223.094
- deferred 2.160
- advanced -9.262
215.992

21) Profit (loss) of the financial year 80.680

Considering the profitability equation:

Considering the 2015-2016 balance sheet, the data for the equation are the following:

2015 2016 average

Net Profit 80.680
Average equity (E) 1.125.687 1.206.365 1.166.026
Ebit 1.106.064
Average invested capital 8.274.581 12.731.357 10.502.969
Negative interests 518.277
Financial debt (D) 9.336.943
Adjusted pretax profit 587.787

The invested capital for 2015 and 2016 is:

Collected (invested) capital 2015 2016 average

Equity 1.125.687 1.206.365 1.166.026
Long-term financial debts 520.000 1.968.961 1.244.481
Current financial debts 6.628.894 9.556.031 8.092.463
Total financial debts 7.148.894 11.524.992 9.336.943
Total collected (invested) capital 8.274.581 12.731.357 10.502.969
21
The total collected (invested) capital is represented by the sum of equity and total financial debts.
The reclassified data for the equation are:

Net Profit / Equity 6,92% ROE

EBIT / Invested capital 10,53% ROI
Negative interests / financial debt 5,55% i
Financial debt / Equity 800,75% D/E (leverage)
Net Profit / adjusted pretax profit 0,14 Rn/Rn*
ROI - i 4,98%
(ROI - i)*D/E 39,88%

Once we have determined ROE, ROI, I, D/E, and Rn/Rn*, the profitability equation can be calculated
as follows:

Net Profit / Equity ROI (ROI - i) (ROI - i) * D/E Rn/Rn* ROE

6,92% 10,53% 4,98% 0,3988 0,14 = 6,92%
References

Miller M.H., (1988), The Modigliani-Miller propositions after thirty years, Journal of Economic
perspectives, Fall.

Modigliani F., Miller M.H., (1958), The Cost of Capital, Corporation Finance and the Theory of
Investment, American Economic Review, June.

Ross S.A., (1988), Comment on the Modigliani-Miller Propositions, Journal of Economic

perspectives, Fall.

Stern J.M., Stewart G.B., Chew D.H., (1995), The EVA® Financial Management System, Journal of
Applied Corporate Finance, Summer.

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