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Basic Question 4 of 6
You are given the following financial data: net income/sales = 4%; sales/total assets = 4.5; debt/total assets = 60%. What is the firm's return on equity?
B. 18%
C. 45%
A. 8.5%
B. 18%
C. 45%
User Contributed Comments 17
| User | Comment |
|---|---|
| kalps | How is this calculated, are they saying it is Sales/total assets ???? |
| gjwhite | equity = assets - liab --> equity/assets = 1 - liab/assets = 1 - .6 = .4 --> assets/equity = 1/.4 = 2.5 = financial leverage therefore ROE = 4 x 4.5 x 2.5 = 45 |
| cbb1 | Return on Equity = Operating Profit % of 4% Multiplied By Asset Turnover (sales/total asset) of 4.5 Multiplied by Equity Multiplier (asset/equity) of 2.5 Compute the 2.5 since debt to total assets equals 60%, equity to total assets must be 40% and then take the reciprocal results in 2.5 |
| richcfa2 | don't forget this if they ask** trick |
| mtcfa | I guess this makes the previous question valid. |
| ninagraham | how did they calculate the equity multiplier as 2.5? |
| jasonk | hi nina, take a look at answer/explanation from cbb1. |
| todolist | Cool Q. |
| viannie | asset = liability + equity if debt / asset = 60% asset being 100%, then equity/total asset = 40% total asset = 1/0.4 = 2.5 thanks cbb1! |
| rocyang | indeed cool question. But, how can you determine if the final output should be in percentage? |
| Gpcurve | Assume Assets = 100 Sales = 4.5 x 100 = 450 NOI = 450 x 4% = 18 Equity = 100 x (1-60%) = 40 ROE = 18/40 = 45% |
| bsm9 | Thanks gpcurve! |
| KarenMaciel | i like this question!!! |
| robertucla | Analystnotes pisses me off when doesn't provide solution. |
| ldfrench | ^Heard that, brother |
| Kevdharr | If a firm's debt/total assets ratio is 60%, then it stands to reason that their equity/total assets would be 40%. DuPont formula requires you to use the equity multiplier in which is total assets/common equity. So if you just take the inverse of equity/total assets (which is 40%), you get 2.5 (1/.4=2.5). You are already given the other two parts of the equation. So just multiply 4*4.5*2.5 and you get 45. |
| ioanaN | assets=debt+equity debt/assets+equity/assets=1 equity/assets=1-debt/assets=1-0.6=0.4 assets/equity=1/0.4=2.5 |
Thanks again for your wonderful site ... it definitely made the difference.
Craig Baugh
Learning Outcome Statements
demonstrate the application of DuPont analysis of return on equity and calculate and interpret effects of changes in its components
CFA® 2024 Level I Curriculum, Volume 3, Module 11.