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BU121 Lecture Notes - Variable Cost, Asset, Operating Leverage

Course Code
Laura Allan

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BU121 Week 8 Lecture 2
Profitability and Efficiency
Measures how efficiently a venture controls its expenses and uses its assets
o Better we control our expenses, the more profitable we will be
o How well are we using our assets?
Accounting-based measures of profitability are a standard starting point for
examining venture value
Gross Profit Margin
= (net sales cost of goods sold) / net sales
As a percentage of my sales, what percent am I grossing on it?
Operating Profit Margin
= EBIT / net sales
= 8.17%
Net Profit Margin
= net income / net sales
= 3.3%
NOPAT Margin
= EBIT (1-tax rate) / net sales
Net Operating Profit After Taxes
Removes impact of leverage and interest tax shield
Interest tax shield: benefit you get from taxes because of the interest
Sales-to-Total Assets
= net sales / average total assets

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What sales are we getting for the assets we had to invest?
Operating Return on Assets
= EBIT / average total assets
The venture‟s basic earning power
Needs to be > interest to benefit from leverage
Take the actual interest rate on the income statement and compare that to the
interest they are paying
Return on Assets (ROA)
= net income / average total assets = 4.8%
Total return on assets depends on sales making on those assets and the return your
making on the sales
OR ROA Model
Represents ROA as the joint outcome of two distinct aspects of the venture‟s
= net profit margin x sales-to-total assets
= net income / net sales x net sales / average total assets
Return on Equity (ROE)
= net income / average owners‟ equity = 12.46%
Shows magnifying effect of leverage
OR ROE Model
Represents ROE as the outcome of the ROA Model and the Equity Multiplier
= ROA x Equity Multipler
= net profit margin x sales-to-total assets x equity multiplier
= (net income / net sales) x (net sales / average total assets) x ( avg total assets /
owners equity)
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