uentin Abay, CFA, is an analyst for a private equity firm interested in purchasing Bickchip Enterprises, a conglomerate. His first task is to determine the trends in ROE and the main drivers of the trends using DuPont analysis. To do so he gathers the data in Exhibit 1.

After conducting the DuPont analysis, Abay believes that his firm could increase the ROE without operational changes. Further, Abay thinks that ROE could improve if the company divested segments that were generating the lowest returns on capital employed (total assets less non-interest-bearing liabilities). Segment EBIT margins in 2009 were 11 percent for Automation Equipment, 5 percent for Power and Industrial, and 8 percent for Medical Equipment. Other relevant segment information is presented in Exhibit 2.

Abay is also concerned with earnings quality, so he intends to calculate Bickchip’s cash-flow-based accruals ratio and the ratio of operating cash flow before interest and taxes to operating income. To do so, he prepares the information in Exhibit 3.

1. Over the three-year period presented in Exhibit 1, Bickchip’s return on equity is best described as:

A. stable.

B. trending lower.

C. trending higher.

2. Based on the DuPont analysis, Abay’s belief regarding ROE is most likely based on:

A. leverage.

B. profit margins.

C. asset turnover.

3. Based on Abay’s criteria, the business segment best suited for divestiture is:

A. medical equipment.

B. power and industrial.

C. automation equipment.

4. Bickchip’s cash-flow-based accruals ratio in 2009 is closest to:

A. 9.9%.

B. 13.4%.

C. 23.3%.

5. The cash-flow-based accruals ratios from 2007 to 2009 indicate:

A. improving earnings quality.

B. deteriorating earnings quality.

C. no change in earnings quality.

6. The ratio of operating cash flow before interest and taxes to operating income for Bickchip for 2009 is closest to:

A. 1.6.

B. 1.9.

C. 2.1.

7. Based on the ratios for operating cash flow before interest and taxes to operating income, Abay should conclude that:

A. Bickchip’s earnings are backed by cash flow.

B. Bickchip’s earnings are not backed by cash flow.

C. Abay can draw no conclusion due to the changes in the ratios over time.

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EXHIBIT 1 Selected Financial Data for Bickchip Enterprises (€ Thousands) 2009 2008 72,448 66,487 6,270 4,710 5,101 4,114 4,038 3,345 Revenue Earnings before interest and tax Earnings before tax Net income Asset turnover Assets/Equity 0.79 3.09 0.76 3.38 2007 55,781 3,609 3,168 2,576 0.68 3.43 EXHIBIT 1 Selected Financial Data for Bickchip Enterprises (€ Thousands) 2009 2008 72,448 66,487 6,270 4,710 5,101 4,114 4,038 3,345 Revenue Earnings before interest and tax Earnings before tax Net income Asset turnover Assets/Equity 0.79 3.09 0.76 3.38 2007 55,781 3,609 3,168 2,576 0.68 3.43

Answer rating: 100% (QA)

Solution 1 C is correct The ROE has been trending higher ROE can be calculated by multiplying Net profit margin asset turn over Finnacial leverage Net ... View the full answer