Below Are Three Relationships That Are Important to the Determination $= \underline { \text { Earnings before interest but after taxes } }$

question 12

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 $= \underline { \text { Earnings before interest but after taxes } }$
Average assets.
2. Financial structure leverage $= \frac { \text { Net income available to common shareholders } } { \text { Earnings before interest but after taxes } }$
3. $\mathrm { ROCE } = \mathrm { ROA } \times$ Common earnings leverage $\times$ 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?
$\begin{array}{|l|c|c|c|}\hline \text { As of Dec. } 31 & \mathbf{2 0 0 9} & \mathbf{2 0 1 0} & \mathbf{2 0 1 1} \\\hline \text { ROA } & 0.10 & 0.10 & 0.08 \\\hline \text { Assets } & \$ 27,500,000 & \$ 23,000,000 & \$ 27,600,000 \\\hline \begin{array}{l}\text { Net income available to common } \\\text { shareholders }\end{array} & \$ 67,250,000 & \$ 68,960,210 & \$ 70,910,840 \\\hline \begin{array}{l}\text { Earnings after taxes but before } \\\text { interest }\end{array} & \$ 25,000,000 & \$ 24,541,000 & \$ 24,794,000 \\\hline\end{array}$

---

Definitions:

Profit Markup

The amount added to the cost price of goods to cover overhead and profit; a measure of the profit margin.

Restructuring Write-Offs

Expenses incurred when a company reorganizes its operations, including costs related to laying off employees, closing facilities, or exiting certain market segments.

Company Balance Sheets

A financial statement that shows an organization's assets, liabilities, and equity at a specific point in time, providing a snapshot of its financial condition.

Sustainable Operating Earnings

The portion of a company's profit that is expected to continue in the future, excluding any one-time items or unusual income.