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Interpreting financial ratios:
If one company’s ROCE is superior to the other, We look behind the figures and consider other reasons for the superiority.
in Becker question bank, there are two companies(Grappa and Merlot), Merlot has the higher ROCE and don’t have its own premise.the company is operating from a leased factory.In the answer, they said if Merlot’s rental cost, as a percentage of the value of the related factory, was less than its overall ROCE, then it would be contributing to its higher ROCE?
Q1:what does that mean ? How can you compare two different things against each other ?
And also said,
Finance cost of the leased assets at only 7.5% is much lower than overall ROCE (of either company) and therefore this does help to improve Merlo’ts ROCE?Q2: why they are comparing leased finance cost with ROCE ?
If you can borrow money at 7.5% and use that money to earn more than 7.5% (ROCE), then you can conclude that the borrowing is worthwhile because it is improving return on capital employed
It doesn’t have to be money that is involved
If you have the right to use an asset and it’s costing you $5,000 for that privilege, if that asset contributes >$5,000 to profits, then it’s a worthwhile situation and we can conclude that that situation is contributing to an increase in ROCE
Is that better?
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