This document discusses various metrics used to measure corporate performance, including market value added, economic value added, book rates of return, and financial ratios. It provides definitions and examples of calculating return on capital, return on assets, return on equity, asset turnover ratio, operating profit margin, long-term debt ratio, and times interest earned ratio using financial data from Lowe's income statement and balance sheet. The purpose of the various metrics and ratios is to evaluate corporate performance, profitability, efficiency, and leverage.

1. McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

2. 3-
2
Corporate Performance

3. 3-
3
Corporate Performance Measured

4. 3-
4
Market Value Added
What is it?
Why is it useful?
Defined:
Book Value Market Value Added [Share Price = ´ Shares Outstanding] - Equity

5. Book Value Market Value Added [Share Price Shares Outstanding] = ´ - Equity
3-
5
MVA: Discussion
Consider AT&T and Home Depot
Similar MVA, Different Market-to-Book Ratio
Why?
TABLE 4.3

6. 3-
6
Economic Value Added
What is it?
Why is it important?
Why is it called residual income?
Defined:
Economic Value Added Operating Income* - [Cost of Capital = ´Total Capitalization]

7. Economic Value Added Operating Income - [Cost of Capital = ´Total Capitalization]
3-
7
EVA: Discussion
Consider Coca-Cola and Google
Similar EVA, Different Return on Capital
Why?
TABLE 4.4
* Operating Income = Net Income + After-tax Interest; ROC = Return on Capital

8. 3-
8
Book Rates of Return*
What do they measure?
Return on Capital:
Return on Assets:
Return on Equity:
*Book Rates of Return are also referred to as Accounting rates of Return

9. 3-
9
Calculating Return on Capital
Assets 2009 2008
Current assets:
Cash and cash equivalents $ 632 245
Short-term investments 425 416
Merchandise inventory - net 8,249 8,209
Deferred income taxes - net 208 105
Other current assets 218 215
Total current assets 9,732 9,190
Property less acc. depreciation 22,499 22,722
Long-term investments 277 253
Other assets 497 460
Total assets $ 33,005 32,625
Liabilities and Shareholders' Equity 2009 2008
Current liabilities:
Short-term borrowings $ - 987
Current maturities of long-term debt 552 34
Accounts payable 4,287 4,109
Accrued comp./employee benefits 577 434
Deferred revenue 683 674
Other current liabilities 1,256 1,322
Total current liabilities 7,355 7,560
Long-term debt, excl. current maturities 4,528 5,039
Deferred income taxes - net 598 599
Other liabilities 1,455 1,372
Total liabilities 13,936 14,570
Shareholders' equity: - -
Common stock - $.50 par value 729 735
Capital in excess of par value 6 277
Retained earnings 18,307 17,049
Acc. other comprehensive income 27 (6)
Total shareholders' equity 19,069 18,055
Lowe’s Return on Capital
After Tax Operating Income = Net Income + After-Tax Interest
= 1,783 + 181 = 1,964
Average Total Capitalization = Average Long-Term Debt + Equity
= + =
(23,597 23,094) 23,345.5
ROC = After-Tax Operating Income = 1,964 =
8.4%
Average Total Capitalization 23,345.5
Lowe’s Balance Sheet (in $m) Total liabilities and shareholders' equity $ 33,005 32,625
Lowe's Income Statement 2009
Net sales 47,220
Cost of sales 30,757
Gross margin 16,463
Expenses:
Selling, general and administrative 11,688
Store opening costs 49
Depreciation 1,614
Interest - net 287
Total expenses 13,638
Pre-tax earnings 2,825
Income tax provision 1,042
Net earnings 1,783
2

10. 3-
10
Calculating Return on Assets
Lowe’s Return on Assets Lowe’s Balance Sheet (in $m)
Assets 2009 2008
Current assets:
Cash and cash equivalents $ 632 245
Short-term investments 425 416
Merchandise inventory - net 8,249 8,209
Deferred income taxes - net 208 105
Other current assets 218 215
Total current assets 9,732 9,190
Property less acc. depreciation 22,499 22,722
Long-term investments 277 253
Other assets 497 460
Total assets $ 33,005 32,625
Liabilities and Shareholders' Equity 2009 2008
Current liabilities:
Short-term borrowings $ - 987
Current maturities of long-term debt 552 34
Accounts payable 4,287 4,109
Accrued comp./employee benefits 577 434
Deferred revenue 683 674
Other current liabilities 1,256 1,322
Total current liabilities 7,355 7,560
Long-term debt, excl. current maturities 4,528 5,039
Deferred income taxes - net 598 599
Other liabilities 1,455 1,372
Total liabilities 13,936 14,570
Shareholders' equity: - -
Common stock - $.50 par value 729 735
Capital in excess of par value 6 277
Retained earnings 18,307 17,049
Acc. other comprehensive income 27 (6)
Total shareholders' equity 19,069 18,055
Total liabilities and shareholders' equity $ 33,005 32,625
After Tax Operating Income = Net Income + After-Tax Interest
= 1,783 + 181 = 1,964
Average Total Assets = (33,005 32,625)
ROA After-Tax Operating Income 1,964 6.0%
Average Total Assets 32,815
ROA = After-Tax Operating Income 1,964 6.0%
Total Assets 32,625 Year Beginning
or
= = =
= =
Lowe's Income Statement 2009
Net sales 47,220
Cost of sales 30,757
Gross margin 16,463
Expenses:
Selling, general and administrative 11,688
Store opening costs 49
Depreciation 1,614
Interest - net 287
Total expenses 13,638
Pre-tax earnings 2,825
Income tax provision 1,042
Net earnings 1,783
2
32,815
+
=

11. 3-
11
Calculating Return on Equity
Lowe’s Balance Sheet (in $m) Lowe’s Return on Equity
Assets 2009 2008
Current assets:
Cash and cash equivalents $ 632 245
Short-term investments 425 416
Merchandise inventory - net 8,249 8,209
Deferred income taxes - net 208 105
Other current assets 218 215
Total current assets 9,732 9,190
Property less acc. depreciation 22,499 22,722
Long-term investments 277 253
Other assets 497 460
Total assets $ 33,005 32,625
Liabilities and Shareholders' Equity 2009 2008
Current liabilities:
Short-term borrowings $ - 987
Current maturities of long-term debt 552 34
Accounts payable 4,287 4,109
Accrued comp./employee benefits 577 434
Deferred revenue 683 674
Other current liabilities 1,256 1,322
Total current liabilities 7,355 7,560
Long-term debt, excl. current maturities 4,528 5,039
Deferred income taxes - net 598 599
Other liabilities 1,455 1,372
Total liabilities 13,936 14,570
Shareholders' equity: - -
Common stock - $.50 par value 729 735
Capital in excess of par value 6 277
Retained earnings 18,307 17,049
Acc. other comprehensive income 27 (6)
Total shareholders' equity 19,069 18,055
Total liabilities and shareholders' equity $ 33,005 32,625
Average Total Equity = (19,069 18,055)
ROE Net Income 1,783 9.6%
Average Total Equity 18,562
ROE = Net Income 1,783 9.9%
Equity 18,055 Year Beginning
or
= = =
= =
Lowe's Income Statement 2009
Net sales 47,220
Cost of sales 30,757
Gross margin 16,463
Expenses:
Selling, general and administrative 11,688
Store opening costs 49
Depreciation 1,614
Interest - net 287
Total expenses 13,638
Pre-tax earnings 2,825
Income tax provision 1,042
Net earnings 1,783
2
18,562
+
=

12. 3-
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Financial Ratios and Shareholder Value
Shareholder value depends on good investment and financing decisions.
Financial Ratios help measure the success and soundness of these decisions.

13. 3-
13
Efficiency Ratios
Asset turnover ratio = Sales
Total AssetsYear Beginning
OR* Average Total Assets
How does this ratio measure efficiency?
Receivables Turnover= Sales
= Sales
ReceivablesYear Beginning
How does this ratio measure efficiency?
* Either equation is a legitimate way to calculate the asset turnover ratio

14. 3-
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Efficiency Ratios
Inventory Turnover Ratio= Cost of Goods Sold
InventoryYear Beginning
How does this ratio measure efficiency?
Inventory
Average Days in Inventory=
Year Beginning
(Cost of Goods Sold/365)
How does this ratio measure efficiency?
Receivables
Average Collection Period=
Year Beginning
(Sales/365)
How does this ratio measure efficiency?

15. 3-
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Calculating an Efficiency Ratio
Lowe’s Balance Sheet (in $m)
Assets 2009 2008
Current assets:
Cash and cash equivalents $ 632 245
Short-term investments 425 416
Merchandise inventory - net 8,249 8,209
Deferred income taxes - net 208 105
Other current assets 218 215
Total current assets 9,732 9,190
Property less acc. depreciation 22,499 22,722
Long-term investments 277 253
Other assets 497 460
Total assets $ 33,005 32,625
Liabilities and Shareholders' Equity 2009 2008
Current liabilities:
Short-term borrowings $ - 987
Current maturities of long-term debt 552 34
Accounts payable 4,287 4,109
Accrued comp./employee benefits 577 434
Deferred revenue 683 674
Other current liabilities 1,256 1,322
Total current liabilities 7,355 7,560
Long-term debt, excl. current maturities 4,528 5,039
Deferred income taxes - net 598 599
Other liabilities 1,455 1,372
Total liabilities 13,936 14,570
Shareholders' equity: - -
Common stock - $.50 par value 729 735
Capital in excess of par value 6 277
Retained earnings 18,307 17,049
Acc. other comprehensive income 27 (6)
Total shareholders' equity 19,069 18,055
Total liabilities and shareholders' equity $ 33,005 32,625
Lowe’s Asset Turnover Ratio
+
Average Total Assets = (33,005 32,625)
2
32,815
=
Asset Turnover Ratio = Sales = 47,220 =
1.4
Average Total Assets 32,815
Lowe's Income Statement 2009
Net sales 47,220
Cost of sales 30,757
Gross margin 16,463
Expenses:
Selling, general and administrative 11,688
Store opening costs 49
Depreciation 1,614
Interest - net 287
Total expenses 13,638
Pre-tax earnings 2,825
Income tax provision 1,042
Net earnings 1,783

16. +
Profit Margin= Net Income
Sales
Net Income Operating Profit Margin= After-Tax Interest
3-
16
Profitability Ratios
How does this ratio measure the firm’s profitability?
Sales
When is this ratio potentially more useful than just profit margin?
Note: ROC, ROA, ROE and EVA are also typically considered profitability ratios.

17. 3-
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Calculating a Profitability Ratio
Lowe’s Balance Sheet (in $m)
Assets 2009 2008
Current assets:
Cash and cash equivalents $ 632 245
Short-term investments 425 416
Merchandise inventory - net 8,249 8,209
Deferred income taxes - net 208 105
Other current assets 218 215
Total current assets 9,732 9,190
Property less acc. depreciation 22,499 22,722
Long-term investments 277 253
Other assets 497 460
Total assets $ 33,005 32,625
Liabilities and Shareholders' Equity 2009 2008
Current liabilities:
Short-term borrowings $ - 987
Current maturities of long-term debt 552 34
Accounts payable 4,287 4,109
Accrued comp./employee benefits 577 434
Deferred revenue 683 674
Other current liabilities 1,256 1,322
Total current liabilities 7,355 7,560
Long-term debt, excl. current maturities 4,528 5,039
Deferred income taxes - net 598 599
Other liabilities 1,455 1,372
Total liabilities 13,936 14,570
Shareholders' equity: - -
Common stock - $.50 par value 729 735
Capital in excess of par value 6 277
Retained earnings 18,307 17,049
Acc. other comprehensive income 27 (6)
Total shareholders' equity 19,069 18,055
Total liabilities and shareholders' equity $ 33,005 32,625
Lowe’s Operating Profit Margin
= = + =
OPM Net Income + After-Tax Interest 1,783 181 4.2%
Sales 47,220
Lowe's Income Statement 2009
Net sales 47,220
Cost of sales 30,757
Gross margin 16,463
Expenses:
Selling, general and administrative 11,688
Store opening costs 49
Depreciation 1,614
Interest - net 287
Total expenses 13,638
Pre-tax earnings 2,825
Income tax provision 1,042
Net earnings 1,783

18. 3-
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Leverage Ratios
Long term debt ratio= Long Term Debt
Long Term Debt+Equity
How does this ratio measure leverage?
Long-term Debt Equity Ratio= Long-Term Debt
Equity
How does this ratio measure leverage?

19. 3-
19
Measuring Leverage
Total Debt Ratio= Total Liabilities
Total Assets
How does this ratio measure leverage?
Times Interest Earned= EBIT
Interest Payments
How does this ratio measure leverage?
Cash Coverage Ratio= EBIT+Depreciation
Interest Payments
How does this ratio measure leverage?

20. 3-
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Calculating a Leverage Ratio
Lowe’s Balance Sheet (in $m)
Assets 2009 2008
Current assets:
Cash and cash equivalents $ 632 245
Short-term investments 425 416
Merchandise inventory - net 8,249 8,209
Deferred income taxes - net 208 105
Other current assets 218 215
Total current assets 9,732 9,190
Property less acc. depreciation 22,499 22,722
Long-term investments 277 253
Other assets 497 460
Total assets $ 33,005 32,625
Liabilities and Shareholders' Equity 2009 2008
Current liabilities:
Short-term borrowings $ - 987
Current maturities of long-term debt 552 34
Accounts payable 4,287 4,109
Accrued comp./employee benefits 577 434
Deferred revenue 683 674
Other current liabilities 1,256 1,322
Total current liabilities 7,355 7,560
Long-term debt, excl. current maturities 4,528 5,039
Deferred income taxes - net 598 599
Other liabilities 1,455 1,372
Total liabilities 13,936 14,570
Shareholders' equity: - -
Common stock - $.50 par value 729 735
Capital in excess of par value 6 277
Retained earnings 18,307 17,049
Acc. other comprehensive income 27 (6)
Total shareholders' equity 19,069 18,055
Total liabilities and shareholders' equity $ 33,005 32,625
Lowe’s Times Interest Earned
Ratio
EBIT = Sales - COGS - Expenses - Depreciation
= 47, 220 -30,757 -11,737 -1,614 = 3,112
Times Interest Earned = EBIT = 3,112 =
10.8
Interest 287
Lowe's Income Statement 2009
Net sales 47,220
Cost of sales 30,757
Gross margin 16,463
Expenses:
Selling, general and administrative 11,688
Store opening costs 49
Depreciation 1,614
Interest - net 287
Total expenses 13,638
Pre-tax earnings 2,825
Income tax provision 1,042
Net earnings 1,783

21. 3-
21
Measuring Liquidity
NWC to Total Assets Ratio = Net Working Capital
Total Assets
How does this ratio measure liquidity?
Current Ratio= Current Assets
Current Liabilities
How does this ratio measure liquidity?

22. 3-
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Liquidity Ratios
Cash + Marketable Securities Quick ratio= + Receivables
Current Liabilities
How does this ratio differ form the current ratio? Why might a financial manager prefer it?
Cash Ratio= Cash + Marketable Securities
Current Liabilities
How does this ratio differ from the current ratio? Why might a financial manager prefer it?

23. 3-
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Calculating a Liquidity Ratio
Lowe’s Balance Sheet (in $m)
Assets 2009 2008
Current assets:
Cash and cash equivalents $ 632 245
Short-term investments 425 416
Merchandise inventory - net 8,249 8,209
Deferred income taxes - net 208 105
Other current assets 218 215
Total current assets 9,732 9,190
Property less acc. depreciation 22,499 22,722
Long-term investments 277 253
Other assets 497 460
Total assets $ 33,005 32,625
Liabilities and Shareholders' Equity 2009 2008
Current liabilities:
Short-term borrowings $ - 987
Current maturities of long-term debt 552 34
Accounts payable 4,287 4,109
Accrued comp./employee benefits 577 434
Deferred revenue 683 674
Other current liabilities 1,256 1,322
Total current liabilities 7,355 7,560
Long-term debt, excl. current maturities 4,528 5,039
Deferred income taxes - net 598 599
Other liabilities 1,455 1,372
Total liabilities 13,936 14,570
Shareholders' equity: - -
Common stock - $.50 par value 729 735
Capital in excess of par value 6 277
Retained earnings 18,307 17,049
Acc. other comprehensive income 27 (6)
Total shareholders' equity 19,069 18,055
Total liabilities and shareholders' equity $ 33,005 32,625
Lowe’s NWC to Total Assets Ratio
Net Working Capital = 9,732-7,355 = 2,377
NWC to Total Assets = NWC = 2,377 =
7.2%
Total Assets 33,005
Lowe's Income Statement 2009
Net sales 47,220
Cost of sales 30,757
Gross margin 16,463
Expenses:
Selling, general and administrative 11,688
Store opening costs 49
Depreciation 1,614
Interest - net 287
Total expenses 13,638
Pre-tax earnings 2,825
Income tax provision 1,042
Net earnings 1,783

24. 3-
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The DuPont System
What is it, and what is it used for?

25. 3-
25
The DuPont System: ROA
+
ROA= Net Income Interest
+
Assets
Sales ROA= x Net Income Interest
Assets Sales
Asset
Turnover
Operating Profit
Margin

26. 3-
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ROA Decomposition by Industry

27. 3-
27
The DuPont System: ROE
+
Assets Sales Net Income ROE= x x Interest x Net Income
+
Equity Assets Sales Net Income Interest
Leverage
Ratio Asset
Turnover
Operating
Profit
Margin
Debt
Burden
ROE= Net Income
Equity

28. 3-
28
Sustainable Growth
Plowback Ratio= Earnings-Dividends
Earnings
Payout Ratio= Dividends
Earnings
´
Growth in equity from plowback = Plowback Ratio ROE
Earnings - Dividends Earnings
= ´
Earnings Equity
= Earnings-Dividends
Equity

29. 3-
29
The Role of Financial Ratios
Table 4.8

30. 3-
30
The Role of Financial Ratios

31. 3-
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Appendix A: Average Ratios, by Industry
Table 4.7

32. 3-
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Appendix B: Financial Ratios and Default Risk
Table 4.9