Assume that you own a manufacturing business that revenues $390MM a year and has 15% EBIT margin. The net profit margin is 5%.
Your CFO comes into your office suggesting that the company has a celebration due to its financial performance. He says to you: Your business is giving you a return on your investment(i.e. equity) of $19.5MM a year!
Your invested working capital every year amounts to approximately $21MM
Your total Fixed assets are $788MM
Your WACC is at 10.5%
Current Market Risk Free Rate is at 4%
Average return on the stock market over last 10 years 11%
Your business has a Beta of 1.3
Would you agree with your CFO’s perception of the true reality regarding the return on your equity and reasons for a “celebration”?