Understanding Return on Capital and Efficiency Growth

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What is a key consideration when estimating revenue growth over time?

Estimating growth rates in profits

Decreasing growth rate as the firm becomes larger (correct)

Using historical operating income growth

Ignoring absolute revenues

How is the target operating margin typically set for a firm?

Not considering reinvestment needs

Based on historical operating margins

Setting a margin that the firm will move towards (correct)

By ignoring revenue growth rates

What is a common method for estimating the capital needed for revenue growth and operating margin targets?

Using historical net income figures

Setting a fluctuating sales-to-capital ratio

Assuming constant sales-to-capital ratio (correct)

Neglecting to consider reinvestment needs

How is return on capital (ROC) calculated?

By taking into account operating income and capital invested Signup and view all the answers

What happens to the sales-to-capital ratio as revenues grow over time?

It remains constant at all times Signup and view all the answers

Why is it crucial to adjust the current margin towards the target margin?

To ensure sustainable growth Signup and view all the answers

What is a fatal flaw of management forecasts according to the text?

They are often based on subjective bias. Signup and view all the answers

How is growth earned by a company?

By adding to its asset or capital base and generating returns. Signup and view all the answers

What is one way a company can achieve growth through new investments?

Investing a portion of after-tax operating income in the business. Signup and view all the answers

How is operating margin growth typically achieved by a company?

By managing existing assets efficiently with higher margins. Signup and view all the answers

What is required for a company to grow its earnings, according to the text?

Add to its asset or capital base and generate returns. Signup and view all the answers

In valuing companies, relying on analyst forecasts can lead to what issue according to the text?

An abandonment of making independent judgments. Signup and view all the answers

What is the formula for calculating the expected growth rate in operating income?

Expected Growth Rate = ROCt+1 * Reinvestment rate + (ROCt+1 - ROCt) / ROCt Signup and view all the answers

What is defined as the 'efficiency growth' in the context of return on capital?

Short-term returns from efficiency Signup and view all the answers

What does a firm's reinvestment rate of 50% signify in the context of growth rate calculation?

It is a component of sustainable growth from new investments Signup and view all the answers

How is the efficiency growth calculated when a firm's return on capital changes from 8% to 10%?

(10% - 8%) / 8% Signup and view all the answers

In the context of sustainable growth, what do fundamental growth equations assume about a firm?

The firm can sustain a return on equity or return on capital in the long term Signup and view all the answers

Why is growth from new investments considered sustainable compared to efficiency growth?

Growth from new investments is transitory Signup and view all the answers