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

Corporate Performance

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 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

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 Calculating Return on Capital
Assets 2009 2008
Current assets:

Lowe’s Return on Capital

Cash and cash equivalents $ 632 245
Short-term investments 425 416
Merchandise inventory - net 8,249 8,209
Deferred incom e taxes - net 208 105

After Tax Operating Income = Net Income + After-Tax Interest Other current assets
Total current assets
218
9,732
215
9,190

= 1,783 + 181 = 1,964 Property less acc. depreciation 22,499 22,722

Long-term investments 277 253
Other assets 497 460
Average Total Capitalization = Average Long-Term Debt + Equity Total assets $ 33,005 32,625

(23, 579  23, 094) Liabilities and Shareholders' Equity 2009 2008
  23, 336.5 Current liabilities:
2 Short-term borrowings $ - 987
Current maturities of long-term debt 552 34
After-Tax Operating Income 1,964 Accounts payable 4,287 4,109

ROC    8.4% Accrued com p./employee benefits 577 434

Average Total Capitalization 23,336.5 Deferred revenue

Other current liabilities
683
1,256
674
1,322

Total current liabilities 7,355 7,560

Lowe's Income Statement 2009
Net sales 47,220 Long-term debt, excl. current m aturities 4,528 5,039
Cost of sales 30,757 Deferred incom e taxes - net 598 599
Other liabilities 1,455 1,372
Gross margin 16,463
Expenses: Total liabilities 13,936 14,570
Selling, general and administrative 11,688
Shareholders' equity: - -
Store opening costs 49
Common stock - $.50 par value 729 735
Depreciation 1,614 Capital in excess of par value 6 277
Interest - net 287 Retained earnings 18,307 17,049
Total expenses 13,638 Acc. other comprehensive income 27 (6)

Pre-tax earnings 2,825 Total shareholders' equity 19,069 18,055

Income tax provision 1,042
Net earnings 1,783 Total liabilities and shareholders' equity $ 33,005 32,625
Lowe’s Balance Sheet (in $m)

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 Calculating Return on Assets
Lowe’s Return on Assets Lowe’s Balance Sheet (in $m)
Assets 2009 2008
After Tax Operating Income = Net Income + After-Tax Interest Current assets:
Cash and cash equivalents $ 632 245
= 1,783 + 181 = 1,964 Short-term investments 425 416
Merchandise inventory - net 8,249 8,209
Deferred incom e taxes - net 208 105
(33, 005  32, 625) Other current assets 218 215
Average Total Assets = Total current assets 9,732 9,190
2
Property less acc. depreciation 22,499 22,722
 32,815 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 com p./employee benefits 577 434
Deferred revenue 683 674
Other current liabilities 1,256 1,322

Total current liabilities 7,355 7,560

Lowe's Income Statement 2009
Long-term debt, excl. current m aturities 4,528 5,039
Net sales 47,220 Deferred incom e taxes - net 598 599
Cost of sales 30,757 Other liabilities 1,455 1,372
Gross margin 16,463
Total liabilities 13,936 14,570
Expenses:
Selling, general and administrative 11,688 Shareholders' equity: - -
Store opening costs 49 Common stock - $.50 par value 729 735
Capital in excess of par value 6 277
Depreciation 1,614
Retained earnings 18,307 17,049
Interest - net 287 Acc. other comprehensive income 27 (6)
Total expenses 13,638
Pre-tax earnings 2,825 Total shareholders' equity 19,069 18,055

Income tax provision 1,042 Total liabilities and shareholders' equity $ 33,005 32,625
Net earnings 1,783

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 Calculating Return on Equity
Lowe’s Return on Equity Lowe’s Balance Sheet (in $m)
Assets 2009 2008

(19, 069  18, 055) Current assets:

Average Total Equity = Cash and cash equivalents

Short-term investments
$ 632
425
245
416
2 Merchandise inventory - net 8,249 8,209
Deferred incom e taxes - net 208 105
 18,562 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 com p./employee benefits 577 434
Deferred revenue 683 674
Other current liabilities 1,256 1,322
Lowe's Income Statement 2009
Total current liabilities 7,355 7,560
Net sales 47,220
Cost of sales 30,757 Long-term debt, excl. current m aturities 4,528 5,039
Gross margin 16,463 Deferred incom e taxes - net 598 599
Other liabilities 1,455 1,372
Expenses:
Selling, general and administrative 11,688 Total liabilities 13,936 14,570
Store opening costs 49
Shareholders' equity: - -
Depreciation 1,614
Common stock - $.50 par value 729 735
Interest - net 287 Capital in excess of par value 6 277
Total expenses 13,638 Retained earnings 18,307 17,049
Pre-tax earnings 2,825 Acc. other comprehensive income 27 (6)

Income tax provision 1,042 Total shareholders' equity 19,069 18,055

Net earnings 1,783
Total liabilities and shareholders' equity $ 33,005 32,625

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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.

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 Efficiency Ratios

How does this ratio measure efficiency?

How does this ratio measure efficiency?

* Either equation is a legitimate way to calculate the asset turnover ratio

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 Efficiency Ratios

How does this ratio measure efficiency?

InventoryYear Beginning
Average Days in Inventory=
(Cost of Goods Sold/365)
How does this ratio measure efficiency?

How does this ratio measure efficiency?

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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

Lowe’s Asset Turnover Ratio Short-term investments

Merchandise inventory - net
Deferred incom e taxes - net
425
8,249
208
416
8,209
105
Other current assets 218 215
Total current assets 9,732 9,190

(33, 005  32, 625) Property less acc. depreciation 22,499 22,722

Average Total Assets = Long-term investments

Other assets
277
497
253
460
2 Total assets $ 33,005 32,625

 32,815 Liabilities and Shareholders' Equity 2009 2008

Current liabilities:
Short-term borrowings $ - 987
Sales 44, 270 Current maturities of long-term debt 552 34
Asset Turnover Ratio    1.4 Accounts payable 4,287 4,109

Average Total Assets 32,815 Accrued com p./employee benefits

Deferred revenue
577
683
434
674
Other current liabilities 1,256 1,322

Total current liabilities 7,355 7,560

Lowe's Income Statement 2009
Net sales 47,220 Long-term debt, excl. current m aturities 4,528 5,039
Cost of sales 30,757 Deferred incom e taxes - net 598 599
Other liabilities 1,455 1,372
Gross margin 16,463
Expenses: Total liabilities 13,936 14,570
Selling, general and administrative 11,688
Shareholders' equity: - -
Store opening costs 49
Common stock - $.50 par value 729 735
Depreciation 1,614 Capital in excess of par value 6 277
Interest - net 287 Retained earnings 18,307 17,049
Total expenses 13,638 Acc. other comprehensive income 27 (6)

Pre-tax earnings 2,825 Total shareholders' equity 19,069 18,055

Income tax provision 1,042
Net earnings 1,783 Total liabilities and shareholders' equity $ 33,005 32,625

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 Profitability Ratios
Net Income
Profit Margin=
Sales
How does this ratio measure the firm’s profitability?

Net Income  After-Tax Interest

Operating Profit Margin=
Sales
When is this ratio potentially more useful than just profit margin?

Note: ROC, ROA, ROE and EVA are also typically considered profitability ratios.

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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 incom e taxes - net 208 105
Other current assets 218 215

Lowe’s Operating Profit Margin Total current assets

Property less acc. depreciation

9,732

22,499
9,190

22,722
Long-term investments 277 253
Other assets 497 460
Total assets $ 33,005 32,625

Liabilities and Shareholders' Equity 2009 2008

Net Income + After-Tax Interest 1, 783  181 Current liabilities:

OPM    4.2%
Short-term borrowings $ - 987
Current maturities of long-term debt 552 34
Sales 47, 220 Accounts payable
Accrued com p./employee benefits
4,287
577
4,109
434
Deferred revenue 683 674
Other current liabilities 1,256 1,322

Total current liabilities 7,355 7,560

Lowe's Income Statement 2009
Net sales 47,220 Long-term debt, excl. current m aturities 4,528 5,039
Cost of sales 30,757 Deferred incom e taxes - net 598 599
Other liabilities 1,455 1,372
Gross margin 16,463
Expenses: Total liabilities 13,936 14,570
Selling, general and administrative 11,688
Shareholders' equity: - -
Store opening costs 49
Common stock - $.50 par value 729 735
Depreciation 1,614 Capital in excess of par value 6 277
Interest - net 287 Retained earnings 18,307 17,049
Total expenses 13,638 Acc. other comprehensive income 27 (6)

Pre-tax earnings 2,825 Total shareholders' equity 19,069 18,055

Income tax provision 1,042
Net earnings 1,783 Total liabilities and shareholders' equity $ 33,005 32,625

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 Leverage Ratios

Long Term Debt

Long term debt ratio=
Long Term Debt+Equity
How does this ratio measure leverage?

Long-Term Debt
Long-term Debt Equity Ratio=
Equity
How does this ratio measure leverage?

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 Measuring Leverage
Total Liabilities
Total Debt Ratio=
Total Assets
How does this ratio measure leverage?

EBIT
Times Interest Earned=
Interest Payments
How does this ratio measure leverage?

EBIT+Depreciation
Cash Coverage Ratio=
Interest Payments
How does this ratio measure leverage?

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 Calculating a Leverage Ratio
Lowe’s Balance Sheet (in $m)
Assets 2009 2008

Lowe’s Times Interest Earned Current assets:

Cash and cash equivalents
Short-term investments
$ 632
425
245
416

Ratio
Merchandise inventory - net 8,249 8,209
Deferred incom e taxes - net 208 105
Other current assets 218 215
Total current assets 9,732 9,190

EBIT = Sales - COGS - Expenses - Depreciation Property less acc. depreciation 22,499 22,722
Long-term investments 277 253

 47, 220  30, 757  11, 737  1, 614  3,112 Other assets
Total assets $
497
33,005
460
32,625

Liabilities and Shareholders' Equity 2009 2008

EBIT 3,112
Current liabilities:

Times Interest Earned    10.8

Short-term borrowings $ - 987
Current maturities of long-term debt 552 34

Interest 287 Accounts payable

Accrued com p./employee benefits
4,287
577
4,109
434
Deferred revenue 683 674
Other current liabilities 1,256 1,322
Lowe's Income Statement 2009
Net sales 47,220 Total current liabilities 7,355 7,560
Cost of sales 30,757
Long-term debt, excl. current m aturities 4,528 5,039
Gross margin 16,463 Deferred incom e taxes - net 598 599
Expenses: Other liabilities 1,455 1,372
Selling, general and administrative 11,688
Total liabilities 13,936 14,570
Store opening costs 49
Depreciation 1,614 Shareholders' equity: - -
Interest - net 287 Common stock - $.50 par value 729 735
Total expenses 13,638 Capital in excess of par value 6 277
Retained earnings 18,307 17,049
Pre-tax earnings 2,825 Acc. other comprehensive income 27 (6)
Income tax provision 1,042
Net earnings 1,783 Total shareholders' equity 19,069 18,055

Total liabilities and shareholders' equity $ 33,005 32,625

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 Measuring Liquidity
Net Working Capital
NWC to Total Assets Ratio =
Total Assets
How does this ratio measure liquidity?

Current Assets
Current Ratio=
Current Liabilities
How does this ratio measure liquidity?

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

Cash + Marketable Securities

Cash Ratio=
Current Liabilities
How does this ratio differ from the current ratio? Why might a financial manager prefer it?

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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 incom e taxes - net 208 105

Lowe’s NWC to Total Assets Ratio

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

Net Working Capital = 9,732-7,355  2,377

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
NWC 2,377 Accounts payable 4,287 4,109
NWC to Total Assets    7.2% Accrued com p./employee benefits 577 434

Total Assets 33, 005 Deferred revenue

Other current liabilities
683
1,256
674
1,322

Total current liabilities 7,355 7,560

Lowe's Income Statement 2009
Long-term debt, excl. current m aturities 4,528 5,039
Net sales 47,220 Deferred incom e taxes - net 598 599
Cost of sales 30,757 Other liabilities 1,455 1,372
Gross margin 16,463
Total liabilities 13,936 14,570
Expenses:
Selling, general and administrative 11,688 Shareholders' equity: - -
Store opening costs 49 Common stock - $.50 par value 729 735
Capital in excess of par value 6 277
Depreciation 1,614
Retained earnings 18,307 17,049
Interest - net 287 Acc. other comprehensive income 27 (6)
Total expenses 13,638
Pre-tax earnings 2,825 Total shareholders' equity 19,069 18,055

Income tax provision 1,042 Total liabilities and shareholders' equity $ 33,005 32,625
Net earnings 1,783
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 Appendix A: Average Ratios, by Industry
Table 4.7

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Appendix B: Financial Ratios and Default Risk

Table 4.9

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