Peter Easton, the CEO ofEWHM, did not sleep all night. He knew he was about to lose his lucrative position. And that was so unfair. He had worked so hard the entire year - and delivered. But the financial gods were not in his favor and his ratios were abysmal.

Just before presenting the year's result at the company's annual board meeting, he opened his favorite accounting book, a book that he wrote himself with a few colleagues, and calculated his ratios, based on the book's definitions:Profit Margin = Net Income / Sales = $240 / $6,000 or 4%;ROA = Net Income / Assets = $240 / $12,000 = 2%. Hisasset turnover ratiowas also low,0.5, but that was not an issue. In the heavy construction industry, whereEWHMis operating, this is the standard - and all of his competitors hadexactlythe same asset turnover ratio. The only, modest, good news was realizing he lives, like many accounting instructors, in a tax-free zone, and will not have to pay any taxes on his earnings.

Peter was able to recall thatEWHMhad debt of $10,000, which pays 10% per annum as interest, and no other liabilities.

As a well-educated financial analyst, you are Peter's last hope.

Required:

1. Is there something wrong with Peter's analysis?
2. CalculateEWHM's Return On Equity (ROE) and appropriately break it down to its main components (DuPont analysis).

EWHMmain industry rival, TheRoman&ClydeCompany, is an all equity firm, with owners' equity of $12,000, and operating profits of $1,200.Roman&Clyde, likeEWHM, lives in a tax-free zone.

c.Compare the Return On Assets (ROA) for the two companies. Which is operated more efficiently? What is the source of the difference?

d.Assume the cost of all capital (debt and equity) is 10%. Compare the Residual Income (RI) ofEWHMwith that ofRoman&Clyde.

Answer rating: 100% (QA)

a There are a couple of issues with Peters analysis Firstly he calculated the Profit Margin and ROA ratios incorrectly The correct calculations are as ... View the full answer