FinishChapter5/StartChapter6
FarmJustabunchofassetsAAssetsGenerateeR=ID+IEEquity(E)Debt(D)LiabilitiesIncomeForEquityHoldersIEIncomeforDebtHoldersIDFarmJustabunchofassetsA=D+EAssetsGenerateeR=ID+IE
ROA,ROE,COD(i)ROA=????=????+??????ForeverydollarofassetshowmuchedoesourfarmgenerateDoesnotdistinguishwhogetseROE=??????ForeverydollarofequityhowmucheforequityholdersdoesourfarmgenerateWhatownerscaremostaboutCOD(i)=??????averagecostofdebt(i)IE=NFICO–UL(unpaidlabor)ID=interestexpense
A=D+E,assets=liabilities+equityR=ID+IEIE=NFICO–ULID=cashinterestpaid+changeinaccruedintereste=egeneratedforoutsiders+egeneratedforownersROA=????ROE=??????COD(i)=??????LinksbetweenROA,ROE,andCOD
ImportantDerivation?
RelationshipbetweenROAandROEIfROAithenROEROAAssetsgenerateeatahigherratethentherateatwhichyoucanborrowmoneyimpliesborrowingmoremoneytoinvestinassetsisagoodideaassumingassetscontinuetogenerateROAGoodforownersIfROAithenROEROAAssetsgenerateeatalowerratethenthentherateatwhichyoucanborrowmoneyimpliesborrowingmoremoneytoinvestinassetsisnotagoodideaLessdesirableforowners Whatdoownersanddebtholderswant? ROEROAi
ROAandROEROAandROEaresimilarbutdifferentROAisanindicatorofmanagerialabilityhowmuchreturnthemanagercangeneratewiththeassetsanddebtloadprovidedbyownershipROEismeasuresprofitabilityforownershiphowmuchreturnownersreceivefromtheirinvestment
OneMoreExampleRevenueforperiodending12/31/2012AmountUL25CashCropSales200Ie?CashLivestockSales100TotalRevenue300Id?R?Expensesforperiodending12/31/2012AmountDepreciation100A500otheroperatingexpenses50totaloperatingexpense150E250Cashinterestpaid25DChangeinaccruedinterest0TotalInterestExpense25ROA?Tota