Section A

HeavySteel, a capital-intensive manufacturing firm, has seen its Return on Capital Employed (ROCE) increase from 12% to 18% over the current year. During the same period, its Operating Profit Margin remained completely flat at 10%.

Which of the following is the MOST LIKELY explanation for the increase in ROCE?

ROCE is calculated as PBIT / Capital Employed. It can also be broken down into Operating Profit Margin (PBIT / Revenue) x Asset Turnover (Revenue / Capital Employed). Since the Operating Margin is flat, the increase in ROCE must be driven by an increase in Asset Turnover. This happens if Revenue increases faster than Capital Employed, or if Capital Employed decreases. Heavy depreciation of aging assets without replacement shrinks the asset base (Capital Employed), thereby artificially inflating ROCE.