Question

1. 4.13 Relating ROA and ROCE.

Boston Scientific, a medical device manufacturer, reported net income (amounts in millions) of $1,062 on sales of $5,624 during Year 4. Interest expense totaled $64. The income tax rate was 35%. Average total assets were $6,934.5, and average common shareholders’ equity was $3,443.5. The firm did not have preferred stock out-standing or non-controlling interest in its equity.

a. Compute the rate of ROA. Disaggregate ROA into profit margin for ROA and assets turn-over components.

b. Compute the rate of ROCE. Disaggregate ROCE into profit margin for ROCE, assets turn-over, and capital structure leverage ratio components.

c. Calculate the amount of net income to common shareholders derived from the excess return on creditors’ capital and the amount from the return on common shareholders’ capital.

Answer 1

a. ROA = Net income + Interest ( 1- tax rate ) / Total asset

= 1062 + 64 ( 1- 35% ) / 6934.5

= 15.91%

Profit margin = Net income + interest ( 1- tax rate ) / sales

= 1062 + 64 ( 1- 35%) / 5624

= 19.63%

Asset turnover = sales / Total asset

= 5624 / 6934.5

= 0.81

b. ROCE = Net income - Dividend / common equity

= 1062 - 0 / 3443.5

= 0.31

Profit margin = Net income / Sales

= 1062 / 5624

=0.19

Asset turnover = Sales / total asset

= 5624 / 6934.5

=0.81

Capital structure leverage ratio = Total asset / Equity

= 6934.5 / 3443.5

=2.01

C.Liabilities = Asset - Equity = 6934.5 - 3443.5 = $3491

Return on liabilities = liabilities * ROA = 3491 * 15.91% = $555.42

Cost = interest ( 1- tax rate ) = 64 ( 1- 35 % ) = $41.6

Excess return = Return - cost = 555.42 - 41.6 = $513.82

Return on equity = equity * ROA = 3443.5 * 15.91% = $547.86

Now,

Net income available to shareholders = Return on liabilities + Return on equity

= $513.82 + 547.86

= $1061.68