company\'s financial performance, as measured by its return on equity (ROE). Dep
ID: 2620861 • Letter: C
Question
company's financial performance, as measured by its return on equity (ROE). Depending on the version used, the DuPont equation will deconstruct the firm's ROE, its best measure of financial performance, into two or three important factors, or drivers According to the equation, which of the following factors will directly affect a company's ROE? Check all that apply Market price per share Total assets turnover ratio Net profit margin Most investors and analysts in the financial community observe a firm's ROE closely. The ROE can be calculated by dividing the firm's net income by the shareholders' equity, or it can be reduced into the key factors that drive the ROE. Investors and analysts like to focus on these drivers to develop a more holistic image of what is changing within a company An analyst collected the following fiscal year 2010 data for firms operating in the agricultural sector. Use the data to compute the net profit margin (NPM), total asset turnover (TAT), and equity multiplier (EM) values required for a DuPont analysis. (Note: The following dollar values are expressed in millions of U.S. dollars.) Common Equity $3,933 $6,510 $5,195 Total Net Firm Assets Sales Income NPM TAT EM ROE |? $35,050 $17,078 $37,402 $67,713 $8,170 $24,363 $7,498 $1,113 $3,907 11.07% 13.62% 8.91 0.48 0.65 7.20 Referring to this data, which of the following conclusions is true about the companies' ROEs? O Firm A's equity multiplier indicates that it has the lowest debt ratio of the three firms O Compared to firms B and C, company A does the best job of containing its costs and managing its tax obligations O Compared to companies A and C, company B uses more financial leverage and exhibits the highest debt ratio O Compared to firms B and C, company A's exceptional ROE performance appears to result from its superior efficiency in using its assetExplanation / Answer
a) ROE (Return On Equity) = Net Income / Equity
= (Net Income / Sales) * (Sales / Assets) * (Assets / Equity)
= Net Profit Margin (NPM) * Asset turnover ratio (TAT) * Financial Leverage (EM)
Thus according to equation company's ROE is affected by-
Total Asset Turnover Ratio & Net Profit Margin
b) Firm A TAT = SalesA/AssetsA = 67713/35050 = 1.9319
Firm A ROE = NPMA * TATA * EMA = 11.07% * 1.9319 * 8.91 = 1.91
c) Firm B EM = AssetsB/EquityB = 17078/6510 = 2.6233
Firm B ROE = NPMB * TATB * EMB = 13.62% * 0.48 * 2.6233 = 0.17
d) Firm C NPM = Net IncomeC/SalesC = 3907/24363 = 0.1604 = 16.04%
Firm C ROE = NPMC * TATC * EMC = 16.04% * 0.65 * 7.2 = 0.75
{Firm A's equity multiplier suggests highest financial leverage (1st statement isn't true). Company A has the lowest NPM hence doesn't seem to do a best job of containing its costs etc.. A seems to have high financial leverage (EM). A does have best ROE.}
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