Chapter 4

Measuring
Corporate
Performance

4- 1
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 Topics Covered
4.1 How Financial Ratios Relate to Shareholder Value
4.2 Measuring Market Value and Market Value Added
4.3 Economic Value Added and Accounting Rates of
Return
4.4 Measuring Efficiency
4.5 Analyzing the Return on Assets: The Du Pont System
4.6 Measuring Financial Leverage
4.7 Measuring Liquidity
4.8 Interpreting Financial Ratios
4.9 The Role of Financial Ratios

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 Question

 The GB HI FI Corporation just purchased an expensive piece of

equipment. Assume that the firm planned to depreciate the
equipment over 5 years on a straight-line basis, but Congress then
passed a provision that requires the company to depreciate the
equipment on a straight-line basis over 7 years. Other things held
constant, which of the following will occur as a result of this

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Copyright © 2018 by The McGraw-Hill Companies, Inc. All rights reserved 4- 4
• You have money to invest in the market.
• SAFCO (2020) is trading at SAR 79.00 on June 2, 2020.
• What kind of information do you need in making your decision?

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 Whether or Not to Invest
 Does the company have a consumer monopoly or strong brand
name?
 Does the company have high operational costs, low capital
expenditure, or investment cash outflows?
 Does the company have flat earnings(or profit) or are they on
a consistent upward trend with good margins?

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 Does the company have high and
consistent returns on investment?
 Does the company reinvest earnings and
profit from these investments?
 Does the company have a low debt-to-
equity ratio?
 When earnings(or profit) are low, can
the company repay its debt?

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 Does the company have the ability to
adjust prices for inflation?
 Does the company have enough
earnings to grow?

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SAFCO – HISTORICAL DATA
2019
SAFCO BOOK
Value of Shareholder
Equity
9,662,542,000
=9.6 Billion SAR

Market value (June 2)

= 416,666,666 X 79
= SAR 32,916,666,614
≈ 32 Billions SAR

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SAFCO – HISTORICAL DATA - Dividend

4- 10
 Objective of the Company

Increase the market value of the company

(Market value measured by stock price reflected in the financial
market)
(SAFCO Market Value=SAR 79.00 x Total Shares)
ARAMCO Market Value @32.5 = SAR 6.5 Trillion =1.73 Trillion US$
Market values of some of well known U.S. firms
Company Stock Price Number of Market Value
(January 15, 2015) Shares (mil)
Google $343.03B 339.34M $343.03B
GE $23.73 10.04B $238.40B
Coca-Cola $42.52 4.38B $187.39B
Wal-Mart $87.50 3.22B $279.64B
Apple $107.56 5.86B $641.57B
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Factors That Affect the Market Value
 How is the company doing at a particular time?
 What is happening to other stock prices; that is, how are the
competitors doing?
 How do investors expect the company to perform in the
future?
– Decisions to invest in various projects and the actual
performance of these projects

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Value and Value Added

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Market Value and Market Value Added (1 of 6)

 Market Capitalization
– Total market value of equity, equal to share
price times number of shares outstanding
Market capitalization = (#shares) × (price per share)
 Market Value Added
– Market capitalization minus book value of
equity
MVA = market capitalization - equity book value

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Market Value and Market Value Added (2 of 6)

Home Depot Income Statement (December 31, 2014)

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Market Value and Market Value Added (3 of 6)

Home Depot Balance Sheet (December 31, 2014) $Millions

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Market Value and Market Value Added (4 of 6)

 Market Value Added

– Home Depot

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Market Value and Market Value Added (5 of 6)

 Market-to-Book Ratio
– Ratio of market value of equity to book value
of equity

Market-to-book ratio

16.1

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Market Value and Market Value Added (6 of 6)

 Stock market measures of company performance, 2015.

Companies are ranked by market value added (dollar
values in millions)

 Consider Exxon and Coca Cola

– Similar MVA, Different Market-to-Book Ratio; Why?

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 EVA and Accounting ROR (1 of 6)

 Economic Value Added (EVA)

– Net income minus a charge for the cost of
capital employed; also called residual income
 Residual Income
– Net dollar return after deducting the cost of
capital

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 EVA and Accounting ROR (2 of 6)

 EVA =
after tax operating income -
(cost of capital × total capitalization)

 After tax operating income =

(1 - tax rate) × interest expense + net income

 Total capitalization =
long-term debt + shareholder’s equity

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 EVA and Accounting ROR (3 of 6)

 Home Depot EVA

Total capitalization = $14,691 + $12,522 = $27,213

EVA = [(1-.35) × 830] + 6,345 - (.09 × 27,213) = $4,435.3 million

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 EVA and Accounting ROR (4 of 6)

EVA and ROC,2015. Companies are ranked by EVA (dollar values

in millions)

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 EVA and Accounting ROR (5 of 6)

 Return on Capital (ROC)

– Net income plus after-tax interest as a
percentage of long-term capital
 Return on Assets (ROA)
– Net income plus after-tax interest as a
percentage of total assets
 Return on Equity (ROE)
– Net income as a percentage of shareholders’
equity

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 EVA and Accounting ROR (6 of 6)

Home Depot Profitability Measurements

after − tax  operating  income 6,885
Return  on  capital  =   =   = .253
total  capitalization 27 ,213

after− tax   operating   income 6 , 885

Return   on   assets  =   =    =  . 17
total   assets 40 , 518

net   income 6 ,345

Return   on   equity  =   =    =  . 507
equity 12 , 522

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 Measuring Efficiency – Asset Turnover Ratio

Sales
Asset   turnover  ratio  = 
Total  assets  at  start  of   year
-or-
Sales
Asset   turnover  ratio  = 
Average  total  assets
For Home Depot
Sales 83,176
Asset   turnover  ratio  =   =    =  2.05
Total  assets  at  start  of   year 40,518
-or-
Sales 83,176
Asset   turnover  ratio  =   =   =  2.07
Average  total  assets (39,946 + 40,518)/ 2
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 Measuring Efficiency – Inventory Turnover

cost  of  goods  sold

Inventory  turnover  ratio  = 
inventory  at  start  of   year
54 ,222
Inventory  turnover  ratio  =   =  4. 9
11,057

inventory  at  start  of   year

Average  days  in  inventory  = 
cost  of  goods  sold / 365
11,057
Average  days  in  inventory  =   = 74  days
54 ,222/ 365
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 Measuring Efficiency – Receivables Turnover

sales
Receivables  Turnover  = 
receivables  at  start  of  year
83,176
Receivables  Turnover  = = 59.5
1,398

receivables  at  start  of   year

Average  collection  period  = 
average  daily  sales
1,398
Average  collection  period  =   = 6.1 days
83,176 / 365
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 The DuPont System (1 of 4)

 A breakdown of ROE and ROA into

component ratios

net   income 6 , 345

Profit   margin  =   =    =  . 076
sales 83 , 176

after− tax   operating   income

Operating   profit   margin  = 
sales
6, 345   +  ( 1 −.35 )  ×  830
=   =  . 083
83 , 176

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 The DuPont System (2 of 4)

after − tax   operating   income

ROA  = 
assets

sales after − tax   operating   income

ROA  =  × 
assets sales

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 The DuPont System (3 of 4)

after − tax   operating   income 6 , 884 .5

ROA  =   =    =  . 17
assets 40 ,518

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 Measuring Financial Leverage (1 of 3)

Long-term debt ratio

Long-term debt ratio

Long-term debt-equity ratio

Long-term debt-equity ratio

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 Measuring Financial Leverage (2 of 3)

total  liabilities 30 ,624

Total  debt  ratio  =  =    =  .77
total  assets 39,946

EBIT 10,806
Times  interest  earned  =   =   =  13.0
interest  payments 830

EBIT  + depreciation 10,806 + 1,786

Cash  coverage  ratio  =   =   = 15.2
interest  payments 830

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 Measuring Financial Leverage (3 of 3)

Asset Debt
Turnover Burden

assets sales after −tax  operating  income net  income

ROE  =   ×   ×   ×  
equity assets sales after− tax  operating  income

Leverage Operating Profit

Ratio Margin

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Measuring Liquidity (1 of 2)

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Measuring Liquidity (2 of 2)

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Interpreting Financial Ratios (1 of 3)

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 Interpreting Financial Ratios (2 of 3)
Ratios for comparison

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Interpreting Financial Ratios (3 of 3)

Selected 2015 financial ratios for industry groups

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