[...] The business used $26 million total assets to earn $3.9 million before interest and income tax, or EBIT. Dividing EBIT by total assets gives the rate of return on assets (ROA) earned by the business. In the example, the business earned a 15.0 percent ROA for the year ($3.9 million EBIT ÷ $26 million total assets = 15.0%). Is this ROA merely adequate, fairly good, or very good? Well, relative to what benchmark or point of reference? The business has borrowed money for part of the total $26 million total capital invested in its assets. The average annual interest rate on its debt is 8.0 percent. Relative to this annual interest rate the company’s 15.0 percent ROA is more than adequate. Indeed, the favorable spread between these two rates works to the advantage of the business owners. The business borrows money at 8.0 percent and manages to earn 15.0 percent on the money. Chapter 6 explores the very important issue regarding debt versus owners’ equity as sources of capital to finance the assets of a business and discusses the advantages and risks of using debt capital. [...]
July 23rd, 2009 at 6:03 am
[...] The business used $26 million total assets to earn $3.9 million before interest and income tax, or EBIT. Dividing EBIT by total assets gives the rate of return on assets (ROA) earned by the business. In the example, the business earned a 15.0 percent ROA for the year ($3.9 million EBIT ÷ $26 million total assets = 15.0%). Is this ROA merely adequate, fairly good, or very good? Well, relative to what benchmark or point of reference? The business has borrowed money for part of the total $26 million total capital invested in its assets. The average annual interest rate on its debt is 8.0 percent. Relative to this annual interest rate the company’s 15.0 percent ROA is more than adequate. Indeed, the favorable spread between these two rates works to the advantage of the business owners. The business borrows money at 8.0 percent and manages to earn 15.0 percent on the money. Chapter 6 explores the very important issue regarding debt versus owners’ equity as sources of capital to finance the assets of a business and discusses the advantages and risks of using debt capital. [...]