ROE DecompositionInditex S.A. is the Spain-based parent company of a large number of clothing design,manufacturing and retail subsidiaries. The company's brands include Zara, Pull & Bear, andMassimo Dutti. At the end of the fiscal year ending on January 31, 2009 (fiscal year 2008),the subsidiaries of Inditex operated 4,359 stores across 73 countries, making Inditex one ofthe three largest clothing retailers in the world.The tables in Case Study 2 worksheet show the standardized and adjusted income statementsand balance sheets for Inditex, for the years ended January 31, 2006, 2007 and 2008.Operating lease obligations have been capitalized and the operating lease expense has beenreplaced with depreciation and interest expense, following the procedure described in Chapter4:1. Calculate Inditex's net operating profit after taxes, operating working capital, net noncurrentassets, net debt, and net assets in 2007 and 2008. (Use the effective tax rate [taxexpense/profit before taxes] to calculate NOPAT; Suppose excess cash and marketablesecurities at 8% of sales.)2. Decompose Inditex's return on equity in 2007 and 2008 using the traditional approach(using net operating assets to calculate asset turnover).3. Decompose Inditex's return on equity in 2007 and 2008 using the alternative approach.What explains the difference between Inditex's return on assets and its operating return onassets?Notes:1. An Excel worksheet called ?Case Study 2.xlsx? is attached for solving this case. Pleaseanswer each question in a word document. Please do not just submit the workouts in Excelsheets.2. You do not need to answer the questions for the year 2006.3. In your report submitted, it is recommended that the Excel results are copied and pasted inyour word document in ?Picture? format.4. Investment income: Income coming from interest payments, dividends, capital gainscollected upon the sale of a security or other assets, and any other profit that is made throughan investment vehicle of any kind. In income statements of Inditex?s, you will commonly seean item called investment income; this is where the company reports the portion of the netincome that was obtained through investments made with surplus cash as opposed to beingearned with the company's usual line of business. It is subtracted from operating profit beforenet profit is obtained.

Inditex Inditex (EURm) 2008 Sales Cost of materials (nature) Personnel expense (nature) Inditex (EURm) 2007 (EURm) 2006 10,407 (4,493) (1,703) 9,435 (4,086) (1,473) 8,196 (3,589) (1,251) (910) (803) (674) (1,168) 2,133 0 (84) 2,050 (455) 1,595 (8) 1,587 (1,039) 2,033 (9) (72) 1,953 (474) 1,479 (7) 1,471 (997) 1,685 (5) (74) 1,607 (404) 1,202 (8) 1,194 6,325 148 203 188 6,863 6,000 139 133 165 6,437 5,262 114 89 148 5,613 585 1,055 158 1,466 3,264 464 1,007 45 1,466 2,982 364 824 55 906 2,148 10,127 9,418 7,761 5,055 27 4,414 24 3,641 22 Non-Current Debt Deferred Tax Liability 2,003 343 2,095 197 1,844 179 Other Non-Current Liabilities (non interest bearing) Total non-current liabilities 308 2,655 229 2,522 190 2,214 Current Debt Trade Payables Other Current Liabilities Total current liabilities 234 2,073 84 2,391 371 1,975 112 2,458 145 1,619 121 1,885 TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY 10,127 9,418 7,761 Depreciation and amortization (nature) Other operating income, net of other operating expense (nature) Operating profit Investment income Net interest expense (income) Profit before taxes Tax expense Profit after taxes Minority interest Net profit ASSETS Non-Current Tangible Assets Non-Current Intangible Assets Deferred Tax Asset Other Non-Current Assets Total non-current assets Trade Receivables Inventories Other Current Assets Cash and Marketable Securities Total current assets TOTAL ASSETS LIABILITIES AND SHAREHOLDERS' EQUITY Shareholders' equity Minority Interest Q1 Item Net profit Effective tax rate Net interest expense and investment income after tax Net interest expense after tax Net operating profit after tax (NOPAT) Net investment profit after tax Sales Excess cash and marketable securities @ 8 percent of sales Working capital Non-current operating assets Investment assets Business assets Debt Group equity Capital The items can also be reported on a "net" basis. We use these "net" items below: Working capital Non-current operating assets Net operating assets Net debt Group equity Net capital Q2 Ratio Return on equity Traditional decomposition of ROE Net profit margin (ROS) Asset turnover = Return on assets (ROA) Financial leverage = Return on equity (ROE) Distinguishing operating and financing components in ROE Q3 decomposition Net operating profit margin Operating asset turnover = Return on Operating Assets Return on Operating Assets x (Operating Assets/Business Assets) + Return on Investment Assets x (Investment Assets/Business Assets) = Return on Business Assets Spread Financial leverage = Financial leverage gain ROE = Return on Business Assets + Financial leverage gain Distinguishing operating and financing components in ROE decomposition (using "net" items) Net operating profit margin Net operating asset turnover = Return on Operating Assets Spread Net financial leverage = Financial leverage gain ROE = Return on Business Assets + Financial leverage gain Inditex Inditex (EURm) 2008 Sales Cost of materials (nature) Personnel expense (nature) Inditex (EURm) 2007 (EURm) 2006 10,407 (4,493) (1,703) 9,435 (4,086) (1,473) 8,196 (3,589) (1,251) (910) (803) (674) (1,168) 2,133 0 (84) 2,050 (455) 1,595 (8) 1,587 (1,039) 2,033 (9) (72) 1,953 (474) 1,479 (7) 1,471 (997) 1,685 (5) (74) 1,607 (404) 1,202 (8) 1,194 6,325 148 203 188 6,863 6,000 139 133 165 6,437 5,262 114 89 148 5,613 585 1,055 158 1,466 3,264 464 1,007 45 1,466 2,982 364 824 55 906 2,148 10,127 9,418 7,761 5,055 27 4,414 24 3,641 22 Non-Current Debt Deferred Tax Liability 2,003 343 2,095 197 1,844 179 Other Non-Current Liabilities (non interest bearing) Total non-current liabilities 308 2,655 229 2,522 190 2,214 Current Debt Trade Payables Other Current Liabilities Total current liabilities 234 2,073 84 2,391 371 1,975 112 2,458 145 1,619 121 1,885 TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY 10,127 9,418 7,761 Depreciation and amortization (nature) Other operating income, net of other operating expense (nature) Operating profit Investment income Net interest expense Profit before taxes Tax expense Profit after taxes Minority interest Net profit ASSETS Non-Current Tangible Assets Non-Current Intangible Assets Deferred Tax Asset Other Non-Current Assets Total non-current assets Trade Receivables Inventories Other Current Assets Cash and Marketable Securities Total current assets TOTAL ASSETS LIABILITIES AND SHAREHOLDERS' EQUITY Shareholders' equity Minority Interest Q1 Item A Net profit B Effective tax rate C Net interest expense and investment income after tax D Net interest expense after tax E Net operating profit after tax (NOPAT) (A - F - D) F Net investment profit after tax G Sales 2008 1,587 22.19% (65) (65) 1,652 2007 1,471 24.27% (61) (54) 1,532 0 10,407 (7) 9,435 833 755 275 140 (Total Current Assets - Excess Cash and marketable securities) - (Total current liabilities - interest bearing current portion of debt) 6,212 6,010 (Total non-current assets - Deferred Tax Liability - Non-interest bearing noncurrent liabilities) 833 755 (Excess cash and marketable securities + Investments if any) H Excess cash and marketable securities @ 8 percent of sales I Working capital J Non-current operating assets K Investment assets Remarks (Net Profit + Interest after tax Investment Profit after tax) (8% of Sales) L Operating assets (I + J) M Business assets (K + L) 6,486 7,319 6,150 6,905 N Debt 2,237 2,467 Current Portion of Debt + Non-Current Debt O Group equity 5,082 4,438 Shareholder Equity + Minority Interest P Capital (N + O) 7,319 6,905 The items can also be reported on a "net" basis. We use these "net" items below: Q Working capital R Non-current operating assets S Net operating assets (Q + R) 275 6,212 6,486 140 6,010 6,150 T Net debt (N - H) 1,405 1,712 Total Debt - Excess Cash and Marketable Securities U Group equity V Net capital (T + U) 5,082 6,486 4,438 6,150 Q2 Ratio Return on equity (A / O) Traditional decomposition of ROE Net profit margin (A / G) Asset turnover (G / M) = Return on assets (ROA) Equity Multiplier (M/O) = Return on equity (ROE) Same as I Same as J 31.2% 33.2% PAT / Group Equity 15.2% 1.42 21.7% 1.44 31.2% 15.6% 1.37 21.3% 1.56 33.2% PAT / Sales Sales / Business Assets Q3 Distinguishing operating and financing components in ROE decomposition Net operating profit margin (E / G) 15.9% Operating asset turnover (G / L) 1.60 = Return on Operating Assets 25.5% Business Assets / Group Equity 16.2% 1.53 24.9% Return on Operating Assets x (Operating Assets/Business Assets = L/M) + Return on Investment Assets (F/K) 25.5% 0.89 0.0% 24.9% 0.89 -0.9% x (Investment Assets/Business Assets) = Return on Business Assets (ROBA) 0.11 22.6% 0.11 22.1% Spread Financial leverage = Financial leverage gain 19.7% 0.44 8.7% 19.9% 0.56 11.1% ROE = Return on Business Assets + Financial leverage gain 31.2% 33.2% Distinguishing operating and financing components in ROE decomposition (using "net" items) Net operating profit margin 15.9% 16.2% Net operating asset turnover 1.60 1.53 = Return on Operating Assets 25.5% 24.9% Spread Net financial leverage = Financial leverage gain 20.8% 0.28 5.8% 21.4% 0.39 8.2% ROE = Return on Business Assets + Financial leverage gain 31.2% 33.2% Net Investment Profit after Tax / Investment Assets