Answer to Question #125442 in Finance for yash hariya

Question

Effect of risk on the financial performance of East Africa companies. Provide examples to strengthen your report 

Answer 1

Financial performance of a company is measured using return on equity (ROE) which value the overall profitability of the fixed income per dollar of equity.

The efficiency of the East African companies can be evaluated by applying ROE, since it shows that companies reinvest their earnings to generate future profit.

The growth of ROE may also depend on the capitalization of companies and operating profit margin. If a company is highly capitalized through the risk weighted capital adequacy ratio then the expansion of ROE will be retarded.

If the company can use capital more efficiently, they will have a better financial leverage and consequently a higher ROE. A higher financial leverage multiplier indicates that company can leverage on a smaller base of stakeholder’s fund and produce higher interest bearing assets leading to the optimization of the earnings.

$\text{Return on capital}=$ $\frac{Net income}{Shareholders Equity Capital}$

A company is said to be leveraged if it is financed partially through debt simply because of the tax shield element of debt. Debt will result to a fixed cost, which implies that if the company increases its debt will result to increase in financial leverage.

A company may be computed in different ways but for the purpose of the current study, the researcher used the ratio of earnings before interest and taxes (EBIT) to earnings before taxes (EBT) for calculating degree of financial leverage (DFL). This mode of computation has been adopted because it focuses directly on the impact of interest on income before taxes.

$\text{DFL}=$ $\frac{EBIT}{EBIT-Interest}$