An analyst finds return-on-equity (ROE) a good measure of management performance and wants to compare two firms: Firm A and Firm B. Firm A reports net income of $3.2 million and has a ROE of 18. Firm B reports income of $16 million and has an ROE of 16. A review of the notes to the financial statements for Firm A, shows that the earnings include a loss from smelting operations of $400,000 and that the firm has exited this business. In addition, the firm sold the smelting equipment and had a gain on the sale of $300,000. A similar review of the notes for Firm B discloses that the $16 million in net income includes $2.6 million gain on the sale of no longer needed office property. Assume that the tax rate for both firms is 36%, and that the notes describe pre-tax amounts. What would be the “normalized” ROE for Firm A and for Firm B, respectively?
FirmA incresed from 18 to 18.36080329 FirmB decreased from 16 to 14.336 ?
I’ll take a break from deriv’s and take a stab. I get A’s new Roe at 18.4% B’s at 14.3%
Normalized ROE Firm A - 18.36% Firm B - 14.34%
good, good, and good. well done team.
Reminder to Ali: don’t forget to take changes net of tax
How do you normalize accounts receivable than have been sold? My brain keeps telling me that its two asset accounts (hence no difference) but I know this is wrong. Also say you want to consolidate an operating lease and you have lease payments of $100 for the next 5 years with i=10%. Is it just a simple NPV of the amount you capitalize? Then what are the effects on Net income assuming you have straight line depreciation? Thanks for you help.