Page 19 - CIMA SCS Workbook November 2018 - Day 1 Suggested Solutions

SUGGESTED SOLUTIONS

Novak - Return on Capital Employed (ROCE), asset turnover and operating profit margin

Novak’s ROCE has reduced from 20.9% in 2016 to 17.6% in 2017.

Even a small reduction in the amount of capital employed (down 1.8% year on year to C$ 100,263
million) hasn’t been able to keep this ratio at its previous level, because operating profit has fallen
by a much greater percentage (down 17.2% to C$ 17,683 million).

Breaking down the ROCE into asset turnover and operating profit margin helps to identify where
the main problem lies.

The amount of revenue generated from the capital employed (asset turnover) has stayed fairly
constant. The main problem is that the operating profit margin has fallen significantly. In fact it
was much bigger than PosterRend’s operating profit margin last year, but now it is smaller.

It’s not clear why this has happened. We know that the industry is very competitive, so perhaps
Novak has had to cut some selling prices on older products to compete with generics that are
being manufactured by competitors.

On page 12 of the pre-seen it says that Novak is about to introduce three new products, so
hopefully the company will soon see an upturn in its fortunes.

PosterRend - Return on Capital Employed (ROCE), asset turnover and operating profit margin

PosterRend’s ROCE has reduced from 17.5% in 2016 to 16.0% in 2017.

Its operating profit has actually risen, but not by quite as much as its capital employed (in
particular its borrowings).

Breaking down the ROCE into asset turnover and operating profit margin shows a very different
picture from Novak.

For PosterRend, the operating profit margin has stayed fairly constant, but the asset turnover has
fallen.

If PosterRend has recently introduced a new product, its directors will be pleased to see that
margins are being maintained. However, their main aim next year will be to try to increase the
level of sales generated from the capital employed (asset turnover).

Return on Equity (ROE)

Novak’s ROE has also fallen dramatically, so it is likely that the shareholders will be alarmed by the
company’s performance. This explains why the company’s share price has been falling over recent
months (graph on page 24 of the pre-seen).

PosterRend’s ROE has also gone down, but not as dramatically. Its share price is showing an
upward trend at the moment, so shareholders must be confident about its future prospects.

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