Hey all A quick question off QBank (ID 9062) 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) A) 18.4 and 14.3. B) 16.0 and 18.0. C) 17.1 and 16.9. D) 15.8 and 17.7. The answer Schweser provides is very brief. How do they get the ROE here? Am I just so tired I am missing easy things? 
Equity(A) = 3.2m/.18 = $17.778m Equity(B) = 16m/.16 = $100m NormRet(A) = 3.2m + (400-300)k*(1-.36) = 3.264m NormRet(B) = 16m - 2.6m*(1-.36) = 14.336m NormRoE(A) = 3.264/17.778 = 18.4% NormRoE(B) = 14.336/100 = 14.3% A)
^^same here. quick question to follow up… I may have misread the q wording but is what they are asking consistent with the normalized vs. recurring terms? Isn’t normalized calc’d using either avg hist roe * beg BV or (I forget the other right now but I think it is just the hist ave) they ask for “normalized” but the info given and the choices offered all center on the single period NI after adjusting for non-recurring items?
normalised has nothing to do with beginning/end ROE etc. It’s just the Earnings adjusted for non recurring items and other stuff that distorts the true picture at the company.
same answer A
Ditto on A.
Gotta be A, if it is really as easy as it seems to be.
I come up with A. Maybe the Normalized issue slouis is hinting at is finding the normalized earnings for a cyclical company by using an average EPS for the last five years times the average ROE?
^ Correct. In that case we should be using Avg EPS
sure, that’s the whole graham/dodd thing. but it’s reasonably obvious in the question that’s not what we are dealing with here.
ilvino Wrote: ------------------------------------------------------- > I come up with A. > > Maybe the Normalized issue slouis is hinting at is > finding the normalized earnings for a cyclical > company by using an average EPS for the last five > years times the average ROE? I was jumbling the terms recurring and normalized and it was bothering me so I had to look it up. CFAI text Reading 30 pg 275: Normalization over the Economic Cycle… " The analyst must consider current operating earnings relative to the business cycle… One simplistic method is to average operating earnings over the entire cycle… A slightly more sophisticated method uses average profitability ratios (gross margin) or return ratios (ROE) applied to current period sales or equity to estimate earning power based on the current level of operation." As pointed out, this question asks to normalize and it simply refers to a single stmt period. my bad.
Yup. You use normalisation in quantum mechanics as well, but here we’re talking about the recurring type!
If there was a LOS on quantum mechanics like there is on normalization then I would read that over too. That aside, anyone that’s online at 5am and already able to be a smarta** gets a high 5 from me.
Because there is only one time zone obviously, and that’s in 'muricar.
now, i don’t have the question in front of me. but the first company’s ROE is going to be very similar (can’t remember which direction) as the two effects cancel each other out. and the second company is going to have a significant hit to its ROE of 16… ok, i checked the first firm had small net loss so it’s ROE will be higher than 18. so only A makes sense even before you do calculations OR as a check to your work. obviously, you can’t always do the intuitive check as there could have been 2, 3 (or even all 4) that made logical sense