In this workout, we are going to calculate and compare return on opening equity and return on opening invested capital for York Plc, and Leeds Plc. Using the information provided from their current year income statement and prior year balance sheet. I'm going to build the calculations for York Plc, and then copy them over for Leeds Plc. Let's start with return on equity, and that's calculated by taking net income and dividing it by equity.

And then I copy that over to give the figure for Leeds Plc as well. Now for return on invested capital for this, I'm going to build two extra calculations. First of all, for NOPAT, Which Is calculated by taking EBIT and multiplying it by one minus the effective tax rate. And again, copy that over For Leeds Plc, and then Going to build the calculation for invested capital, and that's equity plus debt, less cash. And again, copy that over for Leeds Plc. We then bring that all together to give return on invested capital, Which is NOPAT divided by invested capital. So there's the calculations done. Now let's compare the figures, and I'm going to start with return on invested capital. We can see that both companies have generated a return on invested capital of 9.4%. When we look at the inputs to these calculations, both Leeds Plc and York Plc have generated the same EBIT in the last year have the same effective tax rate of 20% and have the same amount of invested capital of 425. It's therefore no surprise that both companies have generated the same return on invested capital. What is surprising is that these two companies have very different returns on equity. York Plc generates a return on equity of 10%, whereas Leeds Plc generates a return on equity of 17.9%. So why the difference? We'll notice that although both companies have the same invested capital and generate the same return on this capital, Leeds Plc has much higher leverage. In fact, 60% of Leeds invested capital comes from net debt, whereas just 10% of York Plc's invested capital comes from net debt. Remember that debt financing is cheap for both companies. They pay just 5% interest on their net debt. So if Leeds Plc gets more of its finance from a cheaper source than York Plc, proportionately more, more net income is left over. For the equity investors in Leeds Plc than for York Plc. This results in Leeds Plc having a higher return on equity than York Plc. This highlights that return on equity can be distorted by leverage differences, whereas return on invested capital is unaffected by leverage differences. This is one of the main advantages of using return on invested capital in company analysis. It allows us to compare the efficiency of companies even if they have different levels of leverage.