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Chapter 10. Beyond Their Means: Balance ... > Red Flag 8: A Company Whose Return o...

Red Flag 8: A Company Whose Return on Capital Is Below Its Costs of Funding

Enron was wiping out its shareholders and heading for liquidation well before it collapsed. That’s the contention of short seller James Chanos, who detected Enron’s troubles about a year before the company hit the wall. Chanos says that Enron’s low return on capital was the cornerstone of the negative view taken by his firm Kynikos Associates when it began selling Enron’s shares short in late 2000. The energy trader was only returning 6–7 percent of capital employed before tax and interest, whether the money was provided by shareholders, by owners of its debt, or through financing from firms it was trading with. However, the cost of that capital was at least 9 percent and could easily have been above 10 percent, Chanos estimates.


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