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Financial Ratios
Thirty years ago a Fortune 500 U.S. company would develop strategies with a focus on capital projects located primarily in this country. With the rise of globalization however, companies must now incorporate multi-country initiatives to take advantage of opportunities in revenue growth as well as cost savings. Evaluating capital investment opportunities can take a myriad of forms: return on investment, service price of capital, payback period, return on capital, return on equity, and internal rate of return. Of these options; return on capital, return on equity, and internal rate of return provide "well-known and trusted benchmarks used by investors and institutions to decide between competing investment options" (Investopedia. Return on Equity vs. Return on Capital N.D.)
Return on equity and return on capital have a commonality to them and describe "how much earnings a company can generate from assets" (Investopedia,...
"Return on equity measures a company's profit as a percentage of the combined total worth of all ownership interests in the company" (Investopedia. Return on Equity. N.D), and is calculated by dividing net income by shareholder's equity. Return on capital uses the same formula however, the denominator "also includes the total value of debts owed by the company in the form of loans and bonds" (Investopedia. Return on Equity vs. Return on Capital N.D.).
Understanding internal rate of return first depends on comprehension of the concept of net present value. Net present value "compares the value of a dollar today to the value of that same dollar in the future, taking inflation and returns into account" (Investopedia. Net Present Value N.D.). Net present value "involves calculating the present value of future expected cash flows from an investment using the company's cost of capital or discount rate" (Marshall, D. & McManus,…
Understanding internal rate of return first depends on comprehension of the concept of net present value. Net present value "compares the value of a dollar today to the value of that same dollar in the future, taking inflation and returns into account" (Investopedia. Net Present Value N.D.). Net present value "involves calculating the present value of future expected cash flows from an investment using the company's cost of capital or discount rate" (Marshall, D. & McManus, W. 1996). The discount rate may also be thought of as the hurdle rate "because it represents the minimum rate of return required for an investment to yield a positive net present value" (Marshall, D. & McManus, W. 1996). An investment which yields a positive net present value is likely a capital project that a company will choose to fund.
The internal rate of return of a capital project is "the actual rate of return that will be earned by the proposed investment, and is the discount rate at which the present value of cash flows is equal to zero" (Marshall, D. & McManus, W. 1996). The IRR which is calculated is compared to the firm's discount rate, and if it exceeds this hurdle rate the proposed investment would be considered desirable. An IRR less than the hurdle rate would not be a recommended investment. As an example, assume a company has a cost of capital of 16%, if a future stream of earnings at that discount rate had a net present value of 1,000,000 dollars, then the IRR must exceed 16%. At some point the net present value will equal zero and that is the IRR.
Firms will utilize net present value, internal rate of return, and return on equity in evaluating their capital budgeting decisions. Procter & Gamble and Kimberly Clark respectively 22 and 126 on the Fortune 500 list are the two largest global consumer product companies (CNNMoney.com.2010). These firms have operations strategically placed around the world to maximize revenue generation and realize cost saving advantages. When considering an overseas investment the IRR and ROE calculations can be particularly useful. The cost of capital or hurdle rate for a project in Africa may be
Financial Accounting for Management) Dell Inc. is considered to be a multinational technology business that is in the process of developing, manufacturing, sells, and supporting personal computers and other computer- associated products. Founded in Round Rock, Texas, Dell services somewhere around 76,500 people all over the world as of 2012. Dell had gone through their growth process during the 1980s and 1990s to turn into (for a time) the major seller
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A number of economists suggest that markets are efficient, but this efficiency is merely assumed. In this regard, Batten points out that, "There is no actual proof. It is virtually impossible to test for market efficiency since the 'correct' prices cannot be observed. To get over this hurdle, most tests examine the ability of information-based trading strategies to make above-normal returns. But the results of such tests do not
Trade Act of 1974 on Euro exchange rates? Free Trade has been a key agenda for the past three presidents. In an expanding global market, tariffs and trade policies are more important today than they have been in the past. More and more countries are forming alliances such as the North American Free Trade Agreement (NAFTA), the Asian Alliance, and the European Union (EU). These trade agreements are meant to
Com industry crash after the boom This is a paper examining some of the factors that caused the dot-com crash Many believe the root cause of the dot-com crash was over valuation of stock prices relative to the actual underlying value of the companies themselves. Stocks of Internet companies traded at Price-Earning ratios of higher then 30, buoyed by a speculative bubble. When reality set in for investors many realized that