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

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Definitions:

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