How
we deal with cross holdings will depend upon
whether we are computing a return on capital
or equity, on the one hand, and whether we
are more interested in a return on just the
parent company or a consolidated return, including
cross holdings.
If
we are computing a return only for the parent
company, the adjustments that we need to make
to arrive at return on capital and equity
are as follows:
1.
To derive return on capital for the parent
company, we should consider only the operating
income and capital invested in the parent
company. If working with consolidated statements,
this will require separating out the after-tax
operating income and capital invested in any
consolidated subsidiary from the consolidated
numbers. Minority holdings in other companies
will not affect operating income but the investments
in these holdings should not be included as
part of invested capital.
2.
To derive return on equity for the parent
company, the net income will have to be cleansed
of income from both majority and minority
holdings and the book value of equity should
not include the book value of these holdings.
To
compute returns on a consolidated company,
not including minority holdings, we have to
do the following:
3.
To derive the return on capital for the consolidated
company, we begin with the consolidated operating
income and the invested capital will contain
the consolidated invested capital, inclusive
of minority interests, with investments in
minority holdings netted out.
4.
The return on equity for the consolidated
company is computed using the net income of
the consolidated company with earnings from
minority holdings netted out, and the equity
in the consolidated company augmented by minority
interests and with the investment in the minority
holdings netted out.
While
it is possible to compute return on capital
on a consolidated company with minority holdings,
it is not advisable because of the complexity
associated with bringing in the debt and cash
holdings of the minority holdings into the
equation.25
The return on equity, though, can be computed
fairly easily.
As
a general rule, computing investment returns
for firms with cross holdings is much more
difficult to do than it is for firms without
these cross holdings.
25
Note that only the equity earnings and the
equity investment in minority holdings is
shown on the parent's financial statements.
To get to invested capital in these holdings,
we have to bring in the debt and cash from
these holdings into the invested capital computation
and the operating income from these holdings
into the operating earnings computation. For
a firm with a single minority holding, this
should be feasible but for a firm with dozens
of minority holdings, this will be arduous.
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