Disaggregating return measures for analyzing leverage

Reference no: EM132733091

EXERCISE 1 - Analyzing Financial Leverage for Alternative Financing Strategies

FIT Corporation's return on net operating assets (RNOA) is 10% and its tax rate is 40%. Its net operating assets ($4 million) are financed entirely by common shareholders' equity. Management is considering its options to finance an expansion costing $2 million. It expects return on net operating assets to remain unchanged. There are two alternatives to finance the expansion:

1. Issue $1 million bonds with 12% coupon, and $1 million common stock.

2. Issue $2 million bonds with 12% coupon.

Required -

a. Determine net operating income after tax (NOPAT) and net income for each alternative.

b. Compute return on common shareholders' equity for each alternative (use ending equity).

c. Calculate the assets-to-equity ratio for each alternative.

d. Compute return on net operating assets and explain how the level of leverage interacts with it in helping determine which alternative management should pursue.

EXERCISE 2 - Disaggregating Return Measures for Analyzing Leverage

Selected financial information from Syntex Corporation is reproduced below:

1. NOA turnover (average NOA equals ending NOA) is 2.

2. NOPAT margin equals 5%.

3. Leverage ratio (average NFO/average common equity) is 1.786, and the spread is 4.4%.

Required -

a. Compute return on net operating assets (RNOA).

b. Compute return on common equity using its three major components.

c. Analyze the disaggregation of return on common equity. What is the "leverage advantage (in percent return) accruing to common equity"?

Reference no: EM132733091

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