Understanding Return on Capital and Efficiency Growth
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Questions and Answers

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?

    <p>By taking into account operating income and capital invested</p> Signup and view all the answers

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

    <p>It remains constant at all times</p> Signup and view all the answers

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

    <p>To ensure sustainable growth</p> Signup and view all the answers

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

    <p>They are often based on subjective bias.</p> Signup and view all the answers

    How is growth earned by a company?

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

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

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

    How is operating margin growth typically achieved by a company?

    <p>By managing existing assets efficiently with higher margins.</p> Signup and view all the answers

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

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

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

    <p>An abandonment of making independent judgments.</p> Signup and view all the answers

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

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

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

    <p>Short-term returns from efficiency</p> Signup and view all the answers

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

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

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

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

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

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

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

    <p>Growth from new investments is transitory</p> Signup and view all the answers

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