This excel model allows you to calculate Return on Common Equity (ROCE), Return on Net Operation Assets (RNOA), Financial Leverage (FLEV), Net Borrowing Costs (NBC), etc easily using different methods based on the information that you have. You need just to enter the values and everything will be shown clearly and using graphs.
- Return on Common Equity (ROCE) is a measure of the profitability of shareholders’ equity. It depends on a number of drivers including (1) Return on net operating assets (RNOA), (2) Extent of financial leverage (FLEV) and (3) Spread between RNOA and net borrowing costs
- RNOA is a ratio of net operating income (OI) at (t) relative to net operating assets at (t-1) and represents the profitability of net operating assets. Note that either an increase (OI) or a decreasing NOA or both will increase RNOA. The definition that NOA=(OA-OL) implies that management’s capacity to depend on low-cost operating liabilities (OL) may increase RNOA by decreasing the level of NOA.
- FLEV is called the financial leverage measuring net financial obligations relative to common equity. Provided that net borrowing cost (NBC) is expected to be less than RNOA, a higher FLEV will imply a greater ROCE. There may be times when spread turns negative and thus the impact of leverage will be adverse.
- The term FLEV×(RNOA-NBC) is multiplicative and implies that if (RNOA-NBC)>0, greater leverage will mean greater ROCE.