ExpertMedium2 marksMultiple Choice
ACCA · Question 14 · Interpretation of Financial Statements
Section A
HeavySteel, a capital-intensive manufacturing firm, has seen its Return on Capital Employed (ROCE) increase from 12% to 18% over the current year. During the same period, its Operating Profit Margin remained completely flat at 10%.
Which of the following is the MOST LIKELY explanation for the increase in ROCE?
Section A
HeavySteel, a capital-intensive manufacturing firm, has seen its Return on Capital Employed (ROCE) increase from 12% to 18% over the current year. During the same period, its Operating Profit Margin remained completely flat at 10%.
Which of the following is the MOST LIKELY explanation for the increase in ROCE?
Answer options:
A.
The company increased its selling prices while keeping costs stable.
B.
The company heavily depreciated its aging plant and machinery without replacing them.
C.
The company issued a large amount of new equity shares to hold as cash reserves.
D.
The company experienced a significant increase in administrative expenses.
How to approach this question
Remember the DuPont breakdown: ROCE = Operating Margin x Asset Turnover. If ROCE went up but Margin stayed flat, Asset Turnover (Revenue / Capital Employed) must have gone up. Look for an option that either increases Revenue (without changing margin) or decreases Capital Employed.
Full Answer
B.The company heavily depreciated its aging plant and machinery without replacing them.✓ Correct
ROCE is calculated as PBIT / Capital Employed. It can also be broken down into Operating Profit Margin (PBIT / Revenue) x Asset Turnover (Revenue / Capital Employed). Since the Operating Margin is flat, the increase in ROCE must be driven by an increase in Asset Turnover. This happens if Revenue increases faster than Capital Employed, or if Capital Employed decreases. Heavy depreciation of aging assets without replacement shrinks the asset base (Capital Employed), thereby artificially inflating ROCE.
Common mistakes
Failing to link ROCE to its component parts (Margin and Turnover) and choosing an option that would affect the margin.
Practice the full ACCA FR — Financial Reporting Practice Exam 5
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