Below Are Three Relationships That Are Important to the Determination $=$

question 48

Essay

Below are three relationships that are important to the determination of profitability. Assume assets were $22,900,000 on Dec. 31, 2008.
1. Operating leverage $=$ $\frac{\text { Earnings before interest but after taxes }}{\text { Average assets. }}$

2. Financial structure leverage $=$ $\frac{\text { Net income available to common shareholders }}{\text { Earnings before interest but after taxes }}$


3. $\mathrm { ROCE } = \mathrm { ROA } ^ { \prime }$ Common earnings leverage 'Financial structure leverage
REQUIRED:
Compute the operating leverage, financial structure leverage, and ROCE (rounded to two places). Then use these relationships to analyze how the profitability of X-Mart changed over the three year period below. What does the company need to do to reverse this trend? What are the risks of your strategy?
$\begin{array}{|l|l|l|l|}\hline\text { As of Dec. } 31 & 2009&2010&2011\\\hline \text { ROA } & 0.10 &0.10&0.08\\\hline \text { Assets } & \$ 27,500,000&\$23,000,000&27,600,000 \\\hline \text { Net income available to common shareholders } & \$ 67,250,000 &\$68,960,210&\$70,910,840\\\hline \text { Earrings after taxes but before interest } & \$ 25,000,000&\$24,541,000&\$24,794,000 \\\hline\end{array}$

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Definitions:

Present Value

Today's value of a future money amount or sequence of cash flows, determined by a certain rate of return.

Initial Investment

The initial amount of money invested in a project or venture.

Financial Break-Even

The point at which total revenues equal total costs and expenses, leaving no net gain or loss.

Accounting Basis

Refers to the method under which income and expenses are recognized and reported. The two primary methods are cash basis and accrual basis accounting.