Chapter 4
Profitability Analysis
4-21
in whole or in part.
properties are owned by franchisees; hence, these assets do not appear on Choice’s
financial statements. Starwood also franchises hotels and generates management
because of Choice’s negative shareholders’ equity. Starwood is effectively utilizing
financial leverage, as ROCEs are high. However, the downward trend in ROA to le-
negative (because repurchases of shares decreased cash and increased treasury stock,
which decreased common equity). Effectively, what Choice has done is secure financ-
4.28 Analyzing the Profitability of Two Rental Car Companies.
Computed ratios are as follows:
Avis Budget
Group
Hertz Global
Holdings
2012 2012
Profit Margin for ROA 6.3% 7.4%
Profit Margin for ROCE 3.9% 2.7%
The ROA of the two companies is very similar, just above 3.0%. ROA measures
financing relative to their overall capital structure. Indeed, the leverage of Avis
is approximately three times the level for Hertz. The use of leverage is the pri-
mary difference between ROCE for each company. There is also a slight differ-
ence in the assets turnover, with Avis showing a turnover of 0.523 relative to
Chapter 4
Profitability Analysis
4-22
in whole or in part.
4.29 Analyzing the Profitability of Two Restaurant Chains.
a. The ROA of Brinker steadily declined during the three-year period, primarily
the result of a decreased profit margin for ROA. The principal driver of the de-
creased profit margin for ROA is an increase in the selling and administrative
capital structure leverage ratio in Year 4, but the problem does not give suffi-
cient information to understand the reason. The explanation is that Brinker
issued long-term debt and used the proceeds to repurchase shares of its common
stock.
derstand the reason for the decreased capital structure leverage ratio. It occurs
because the retention of earnings more than offsets increases in long-term debt
and repurchases of common stock.
c. Brinker has a higher ROA than McDonald’s in Year 2, but the declining ROA
of Brinker and the increasing ROA of McDonald’s cause the firms to switch
advertising for both its owned and franchised restaurants in the numerator but
restaurant revenues for its owned restaurants and rent and fees for its franchised
restaurants in the denominator. Brinker’s advantage on total assets turnover
results from higher receivables and fixed asset turnover. McDonald’s likely has
receivables from its franchisees, which is less the case for Brinker. Brinker’s
Chapter 4
Profitability Analysis
4-23
restaurants are larger and more costly than McDonald’s restaurants, but Brinker
generates significantly more revenue per restaurant than McDonald’s does.
Brinker’s sit-down restaurants are more upscale than McDonald’s and likely
Integrative Case 4.1: Starbucks (Part A)
a. Profit Margin for ROA:
Assets Turnover:
Return on Assets:
Profit Margin for ROCE:
Capital Structure Leverage:
Return on Common Shareholders’ Equity:
Cost of Sales/Operating Revenues:
Stores Operating Expenses/Operating Revenues:
Other Operating Expenses/Operating Revenues:
Depreciation and Amortization Expenses/Operating Revenues:
General and Administrative Expense/Operating Revenues:
Restructuring Charge/Operating Revenues:
Income from Equity Investees/Operating Revenues:
Interest Revenue/Operating Revenues:
Income Tax Expense (excluding tax effects of interest expense)/Operating Reve-
nues:
Chapter 4
Profitability Analysis
4-24
Accounts Receivable Turnover:
Inventory Turnover:
Fixed Asset Turnover:
b. ROA: Starbucks’ ROA reflects an up then down pattern during 2010–2012. This
pattern is primarily due to a significant increase in the profit margin for ROA during
(as a percentage of revenues) decreased from 4.8% to 4.5%, while other operating
expenses (as a percentage of revenues) increased from 2.6% to 3.4%.
Cost of Sales to Operating Revenues Percentage: The segment data in Text
Exhibit 4.44 indicate that the increase in this expense percentage occurred steadily
year. The MD&A in the annual report indeed attributes the overall cost increase to
increases in the price of coffee. But, they also discuss “lower occupancy costs as a
percentage of total net revenues” driven by “increased sales leverage on occupancy
fied as a factor in the change in cost of sales, but the sales leverage is.
Store Operating Expense to Operating Revenues Percentage: This percentage
decreased for most years and segments, with the exception of an increase in 2012
for the China/Asia Pacific segment. For the Americas segment, the company’s
10-K indicates the following: “Store operating expenses as a percentage of total
Chapter 4
Profitability Analysis
4-25
in whole or in part.
partially offset by higher debit card transaction fees (approximately 20 basis
points).”
Depreciation and Amortization Expense to Operating Revenues Percentage:
General and Administrative Expense to Operating Revenues Percentage: This
percentage is fairly steady for all but the China/Asia Pacific segment. Again, this is
to support the growth of the business.”
Restructuring Charge: Starbucks recognized a $53 million of restructuring
charges were recorded in 2011 or 2012.
c. ROCE follows the same up and down trend as ROA. The level of ROA increased
in the company’s level of outstanding long-term debt. Thus, it is other current lia-
bilities that have increased (such as accrued compensation) at the same time that
Starbucks has been paying dividends and repurchasing common stock (as shown
on the statement of cash flows).
Chapter 4
Profitability Analysis
4-26
in whole or in part.
Integrative Case 4.1: Starbucks (Part B)
a. ROA for Starbucks ranged between 16.2% and 18.5%, whereas ROA for Panera
However, summing various components (like cost of goods sold, fresh dough and
other product costs and pre-opening expenses for Panera, and cost of sales, store
operating expenses, and other operating expenses for Starbucks) reveals that both
have very close margins based on these primary costs. The net profit margin for
Starbucks, however, also includes income from equity investees and interest reve-
nue, which together increase Starbucks’ net margin by 2%–3%. The equity investee
slightly lower. Assets per store for Starbucks are approximately one-third of those
for Panera (for example, $170 thousand for Starbucks’ Americas segment in 2012,
versus $768 thousand for Panera in 2012), likely due to smaller stores differences
in renting versus owning. However, the revenues per store of Starbucks are
expense ratio has fallen for both companies, but has fallen farther for Panera. Both
companies had a ratio of 6.6% in 2012, but Panera reports a decline to 5.5% in 2012
relative to 6.0% for Starbucks. On one hand, the infrastructure to manage Panera’s
food-service operations likely requires additional fixed assets investments, not ne-
tional levels of corporate level coordination.
Average Income Tax Rates: The average income tax rates of Starbucks and
Panera are similar.
As indicated above, the assets turnovers of the two companies are experiencing
different trends, with Starbucks’ assets turnover declining but Panera’s increasing.
Chapter 4
Profitability Analysis
4-27
in whole or in part.
Accounts Receivable Turnover: The accounts receivable turnover of Starbucks is
much below that of Panera. This is likely due to credit items that play a role in the
distribution of products in Starbucks’ licensing and food service operations. The
differences are not important, however, because receivables make up a very small
percentage of total assets.
Fixed Asset Turnover: Fixed asset turnover increased slightly over the three-year
period for both Starbucks and Panera. Overall, assets per store also generally in-
creased for both companies. Starbucks’ comparable stores sales increased at a
much higher rate than those of Panera, which also contributes to Starbucks slightly
higher fixed assets turnovers.
assets turnover. The net is that the segment ROAs of Starbucks’ Americas segment
and Panera’s company-operated retail segment are both well above average, but
Starbucks’ is approximately double that of Panera. For example, in 2012, segment
ROA for the Americas Segment of Starbucks is 94.3%, relative to 47.1% for
example, Panera has a very profitable franchising operation but a low-margin food
service operation. Starbucks also generates licensing fees, which are likely profitable
(although we do not have data to figure this out). It also has a profitable consumer
products group operation (with 30%–40% margins), but also has a significant
group.
b. The explanation for Panera’s advantage on ROCE is the same as the explanation
used for its advantage on ROA. The capital structure leverage ratios of Starbucks are
slightly larger than those of Panera, but not sufficiently so to change the overall dif-
ferences.
Chapter 4
Profitability Analysis
4-28
in whole or in part.
Case 4.2: Profitability and Risk Analysis of Walmart Stores (Part A)
a. Return on Assets (ROA)
Studying the changes in ROA and its components, one is struck with the overall
relatively minor changes in the ratios. We explore possible reasons for the minor
changes next.
These slight changes are examined next.
Profit Margin for ROA: The decline in profit margin for ROA is most easily ex-
amined with common-size income, for which excerpts are shown in Text Exhibit
4.52. The interesting observation is that the cost of goods sold to sales percentages
centage continually increased.
2008 2007 2006
The net effect of these changes is a 300 basis point increase in Walmart’s cost
might be due to the following:
• The MD&A indicates that the overall decrease in COGS as a percentage
• The Walmart U.S. and International segments yield higher gross profit
margins than the Sam’s Club segment. The largest growth in number of