4.7 DISADVANTAGES OF FINANCIAL LEVERAGE. The intuition behind the benefits of financial leverage is that a firm can borrow funds that bear a certain inter- est rate but invest those funds in assets that generate returns in excess of that rate. Why would firms with high ROAs not keep leveraging up their firm by borrowing and investing the funds in profitable assets?
4.12 CALCULATING BASIC AND DILUTED EPS. TJX, Inc., an apparel retailer, reported net income (amounts in thousands) of $609,699 for Year 4. The weighted average of common shares outstanding during Year 4 was 488,809 shares. TJX, Inc., subtracted inter- est expense net of tax saving on convertible debt of $4,482. If the convertible debt had been converted into common stock, it would have increased the weighted average common shares outstanding by 16,905 shares. TJX, Inc., has outstanding stock options that, if exercised, would increase the weighted average of common shares outstanding by 6,935 shares. Compute basic and diluted earnings per share for Year 4, showing supporting computations.
4.13 RELATING ROA AND ROCE. Boston Scientific, a medical device manufac- turer, reported net income (amounts in millions) of $1,062 on sales of $5,624 during Year 4. Interest expense totaled $64. The income tax rate was 35 percent. Average total assets were $6,934.5, and average common shareholders’ equity was $3,443.5. The firm did not have preferred stock outstanding or minority interest in its equity.
- Compute the rate of ROA. Disaggregate ROA into profit margin for ROA and assets turnover components.
- Compute the rate of ROCE. Disaggregate ROCE into profit margin for ROCE, assets turnover, and capital structure leverage ratio components.
- Calculate the amount of net income to common shareholders derived from the excess return on creditors’ capital and the amount from the return on common shareholders’ capital.