ROE Exercise: Management of Working Capital and Receivables, and Return on Equity

Chapter 6 ROE Exercise: Management of Working Capital and Receivables, and Return on Equity

Management’s goal is to maximize stockholder wealth by choosing investments (e.g. people, inventories, plant and equipment, other companies) that generate an overall return exceeding the cost of the debt and equity capital used to finance the investments. Stated another way, management must manage its operating, investing, and financing decisions in a manner that maximizes the return on the stockholders’ investment in the company. The ROE model, introduced and illustrated in Appendix 5A, provides a framework linking the management of a company’s operating, investing, and financing activities to its return on the stockholders’ investment (return on equity). The management of a company’s working capital and receivables plays an important role in the ROE model via three financial statement ratios: current ratio (current assets/current liabilities), quick ratio ([cash + short-term investments + accounts receivable]/current liabilities), and receivables turnover (sales/average accounts receivable).

Access the following website (http://www.wiley.com/college/pratt), and conduct ROE analyses on Caterpillar versus Deere & Company and/or IBM versus Hewlett-Packard, paying special attention to how the companies’ solvency positions and receivables turnover impact ROE.

Chapter 7 ROE Exercise: Management of Inventory and Return on Equity

The ROE model, introduced and illustrated in Appendix 5A, provides a framework linking the management of a company’s operating, investing, and financing activities to its return on the stockholders’ investment (return on equity). The management of inventory plays an important role in the ROE model primarily through the inventory turnover ratio. Recall as well that inventory is a current asset, so inventory management also influences working capital and the current ratio, discussed in Chapter 6.

Access the following website (http://www.wiley.com/college/pratt), and conduct ROE analyses on La-Z-Boy versus Furniture Brands, Barnes and Noble versus Borders, or Nordstrom versus Saks, all of which carry substantial investments in inventory, paying special attention to how the companies’ inventory turnover ration impacts ROE.

Chapter 8 ROE Exercise: Managing Investments in Equity Securities and Return on Equity

The ROE model, introduced and illustrated in Appendix 5A, provides a framework for linking the management of a company’s operating, investing, and financing activities to its return on the stockholders’ investment (return on equity). In terms of this model, investments in equity securities can be viewed as either short-term or long-term. Access the following website (http://www.wiley.com/college/pratt), and conduct an ROE analysis on Kellogg versus General Mills and/or AT&T versus SBC Communications, paying special attention to how asset turnover impacts ROE.

Chapter 9 ROE Exercise: Managing Long-Lived Assets and Return on Equity

The ROE model, introduced and illustrated in Appendix 5A, provides a framework for linking the management of a company’s operating, investing, and financing activities to its return on the stockholders’ investment (return on equity). For many companies (e.g. manufacturers, services, and companies that grow via acquisition) the management of long-lived assets is an important investment activity.

Access the following website (http://www.wiley.com/college/pratt), and conduct an ROE analysis on Harrah’s Entertainment versus Caesar’s Entertainment, and/or Kroger’s versus Albertson’s, all of which carry significant investments in long-lived assets, paying special attention to how the management of the companies’ various long-lived assets affects asset turnover, ROA, and ROE.

Chapter 10 ROE Exercise: Managing Current Liabilities

The ROE model, introduced and illustrated in Appendix 5A, provides a framework for linking the management of a company’s operating, investing, and financing activities to its return on the stockholders’ investment (return on equity). The management of the nature and level of current liabilities represents important operating activities.

Access the following website (http://www.wiley.com/college/pratt), and conduct an ROE analysis on Kohls’s versus Dillards, and/or Yahoo! versus Earthlink, all four of which carry significant levels of current liabilities, paying special attention to the relationship between the companies’ leverage and solvency positions.

Chapter 11 ROE Exercise: Managing Long-Term Debt

The ROE model, introduced and illustrated in Appendix 5A, provides a framework for linking the management of a company’s operating, investing, and financing activities to its return on the stockholders’ investment (return on equity). The management of the nature and level of long-term debt represents an important financing activity.

Access the following website (http://www.wiley.com/college/pratt), and conduct an ROE analysis on New York Times versus Washington Post, and/or Dow Chemical versus DuPont, all of which carry significant levels of long-term debt, paying special attention to the companies’ leverage positions. Chapter 12 ROE Exercise: Return on Equity and Value Creation

The ROE model, introduced and illustrated in Appendix 5A, provides a framework for linking the management of a company’s operating, investing, and financing activities to its return on the stockholders’ investment (return on equity). The balance in the stockholders’ equity section of the balance sheet represents the investment made by the stockholders, and it is management’s responsibility to provide a return on that investment exceeding the return the stockholders could have generated if they chose to invest their funds in other equally risky investments. If this objective is achieved, management has “created value” for the shareholders. If return on equity (ROE) is 20 percent in a particular year, for example, and in that year other equally risky investment alternatives generate a return, on average, of 15 percent, management has achieved value creation.

An important part of ROE analysis involves assessing the level and changes in the shareholders’ investment (equity) as well as the returns generated by management on the capital provided or used by those changes. Access the website (http://www.wiley.com/college/pratt), and conduct and ROE analysis on Boston Scientific versus Guidant and/or Georgia-Pacific versus Weyerhaeuser, paying special attention to changes in ROE and transactions that affect stockholders’ equity.

Chapter 13 ROE Exercise: Using the Right Earnings Number

The ROE model, introduced and illustrated in Appendix 5A, provides a framework for linking the management of a company’s operating, investing, and financing activities to its return on the stockholders’ investment (return on equity). A key question addressed by analysts using the ROE model involves choosing the most appropriate earnings number. Since the ROE model is designed to explain ROE, and earnings represents the numerator of that ratio, the quality of ROE analysis can be no better than the quality of the chosen earnings number. “Bottom-line” net income, as discussed in this chapter, includes components that vary in terms of the extent to which they reflect a change in the company’s wealth as well as their persistence, and consequently may not be the best choice in all cases.

Access the website (http://www.wiley.com/college/pratt), and conduct and ROE analysis on Ford Motor Company versus General Motors and/or Abbott versus Bristol-Meyers Squibb, paying special attention to earnings numbers used in the analysis.