McKinsey/Valuation
59
Chapter: Chapter 10: Analyzing Performance
True/False
1. Since profit is measured over an entire year, whereas capital is measured at only one point in
time, it is recommended that return on invested capital (ROIC) use the average of starting and
ending invested capital.
2. With respect to the performance measures return on invested capital (ROIC), return on
equity (ROE), and return on assets (ROA), which of the following is most accurate concerning
the relative superiority of the three as analytical tools for understanding a company’s
performance?
a) ROE is better than ROA, which is better than ROIC.
b) ROA is better than ROIC, which is better than ROE.
c) ROIC is better than ROA, which is better than ROE.
d) ROE is better than ROIC, which is better than ROA.
3. Compute ROIC given the following information: EBITA = $800, revenues = $2,200, invested
capital = $4,000, operating cash tax rate = 34%.
a) 6.8 percent.
b) 13.2 percent.
c) 24.0 percent.
d) 36.3 percent.
4. You are an equity analyst and have computed the following figures for two cement
companies. The first, CementCo, has NOPLAT of $1,550 million, invested capital without
goodwill of $15,000 million, and goodwill of $1,950 million. The second, CementExports, has
NOPLAT of $1,750 million, invested capital without goodwill of $16,000 million, and no
goodwill. If the cost of capital for both firms is 10 percent, what is the ROIC for each company?
Which company is creating value in this year?
a) ROIC excluding goodwill is 10.3 percent for CementCo and 10.9 percent for CementExports;
both companies are creating value.
b) ROIC including goodwill is 9.1 percent for CementCo and 10.9 percent for CementExports;
both companies are creating value.
c) ROIC including goodwill is 9.1 percent for CementCo and 10.9 percent for CementExports;
only CementExports is creating value.
d) ROIC including goodwill is 9.1 percent for CementCo and 10.9 percent for CementExports;
neither of the companies is creating value.
5. An analyst would include goodwill in invested capital when measuring aggregate value
creation for a company’s shareholders.
McKinsey/Valuation
61
6. ROIC excluding goodwill is useful when measuring underlying operating performance of the
company and its businesses, and it is useful for comparing performance against peers and to
analyze trends.
7. A company’s ROIC is driven by its ability to maximize profitability (EBITA divided by revenues
or the operating margin), optimize capital turnover (measured by revenues over invested
capital), or minimize operating taxes.
Use the following table, which provides historical data for SnacksCo, a manufacturer of snack
foods, to answer the next four questions. Assume an operating tax rate of 30 percent and a cost
of capital of 9 percent.
Income statement
Year 1
Year 2
Revenues
540.0
555.0
Cost of sales
(350.0)
(360.5)
Selling, general, and
administrative
(50.0)
(50.5)
Depreciation
(10.0)
(10.5)
EBIT
130.0
133.5
Interest expense
(7.5)
(7.5)
Gain/(loss) on sale of assets
–
(30.0)
Earnings before taxes
122.5
96.0
Taxes
(24.8)
(21.5)
McKinsey/Valuation
62
Net income
97.7
74.5
Balance sheet
Year 2
Operating cash
15.0
Excess cash and marketable
securities
100.0
Accounts receivable
94.5
Inventory
157.5
Current assets
367.0
Property, plant, and equipment
219.8
Equity investments
180.0
Total assets
766.8
Accounts payable
119.6
Short-term debt
45.0
Accrued expenses
89.0
Current liabilities
253.7
Long-term debt
80.6
Common stock
120.0
Retained earnings
312.5
Total liabilities and equity
766.8
Multiple Choice
McKinsey/Valuation
63
8. What is SnackCo’s operating margin in year 2?
a) 13.4 percent.
b) 16.8 percent.
c) 24.0 percent.
d) 35.3 percent.
9. What is SnackCo’s capital turnover in year 2 using average invested capital?
a) 2.1
b) 2.0
c) 1.5
d) 0.5
10. What is SnackCo’s ROIC in year 2?
a) 20.3 percent.
b) 24.8 percent.
c) 33.6 percent.
d) 35.4 percent.
11. SnackCo is creating value in year 2.
12. Which of the following is the best method of determining whether the financial
performance between competitors is sustainable?
a) Linking operating drivers directly to return on capital.
b) Comparing the respective ROE and ROA measures.
c) Breaking ROE down into ROIC, tax, interest rate, and leverage effects.
d) Distinguishing between pretax ROIC and the operating-cash tax rate.
McKinsey/Valuation
65
Rental expense
0
248
General expenses
562
528
Depreciation
139
136
Interest expense
39
30
Income taxes
5
8
13. Using the preceding table, if receivables, inventories, and other current assets are $520 in
2015, then what is the number of days in cash?
a) 28 days.
b) 29 days.
c) 30 days.
d) 31 days.
14. In order to get a more accurate forecast of revenue growth, an analyst should remove the
effects of which of the following?
I. Deferred taxes.
II. Changes in currency values.
III. Mergers and acquisitions.
IV. Changes in accounting policies.
a) I and II only.
b) I and III only.
c) III and IV only.
d) II, III, and IV only.
15. Assuming that both the acquiring and target firms have fiscal years ending on December 31,
if the target is acquired on December 1, 2015, which of the following is the most accurate?
a) Revenues of the target would be consolidated from 2016 onward.
b) Revenues of the target would be consolidated 100 percent for 2015.
c) Revenues of the target would be consolidated post-acquisition—that is, one month of
revenues of the target for 2015.
d) No consolidation of revenues will happen.
True/False
16. Liquidity measures the company’s ability to meet obligations over the short term.
17. Leverage measures the company’s ability to meet obligations over the long term.
18. The company’s ability to meet short-term obligations is measured with ratios that
incorporate three measures of earnings. Which of the following is NOT one of those measures
of earnings?
a) Earnings before interest, taxes, and amortization (EBITA).
b) Earnings before interest, taxes, depreciation, and amortization (EBITDA).
c) Earnings before interest, taxes, amortization, and preferred dividends (EBITAD).
d) Earnings before interest, taxes, depreciation, amortization, and rental expense (EBITDAR).
True/False
19. By using the debt-to-EBITDA ratio, one can build a more comprehensive picture of the risk
of leverage.
20. To evaluate leverage in the recent low-interest-rate environment, many analysts are now
evaluating debt multiples such as debt to EBITDA or debt to EBITA.
21. With regard to the interest coverage ratio, which of the following is the most accurate?
a) If near-term bankruptcy is an issue, EBITDA can be used to measure survival only over the
short term.
b) EBITDA should be used to measure survival over both the short and the long term.
c) EBITA should be used to measure survival only in the short term (vs. long term).
d) None of the above are true.
22. Use the following data to answer the question: What are the three interest coverage ratios
based on pretax income and interest expense?
2015
2016
Current assets
$860
$896
Current liabilities
710
818
Debt in current liabilities
1
39
Long-term debt
506
408
Total assets
2,293
2,307
Capital expenditures
111
117
Change in deferred taxes
–29
–20
Sales
4,100
4,200
Operating expenses
3,307
3,260
Rental expense
0
248
General expenses
562
528
Depreciation
139
136
Interest expense
39
30
Income taxes
5
8
a) For 2016, interest coverage ratios based on EBIT, EBITDA, and EBITDAR are 5.47, 5.47, and
1.48, respectively.
b) For 2016, interest coverage ratios based on EBIT, EBITDA, and EBITDAR are 2.36, 5.92, and
13.73, respectively.
c) For 2016, interest coverage ratios based on EBIT, EBITDA, and EBITDAR are 0.93, 5.47, and
1.48, respectively.
d) For 2016, interest coverage ratios based on EBIT, EBITDA, and EBITDAR are 0.93, 5.47, and
13.73, respectively.
McKinsey/Valuation
69
]
23. For a given company, the return on invested capital (ROIC) is 13.5 percent, the tax rate is 34
percent, and the pretax cost of debt is 8.8 percent. If its debt-to-equity ratio is equal to 2.0,
what is the return on equity (ROE)?
a) 16.30 percent.
b) 17.80 percent.
c) 28.88 percent.
d) 25.30 percent.
24. Given that ROIC, the interest rate on debt, and the debt-to-equity ratio are constant, how
will increasing the tax rate affect ROE?
a) Decrease it.
b) Not affect it.
c) Increase it.
d) There is no set relationship.
25. An analysis of a company’s historical financial performance should go back a maximum of
five years.