Using the Du Pont method, evaluate the effects of the following relationships fo

Question

Using the Du Pont method, evaluate the effects of the following relationships for the Butters Corporation.  
  
a. Butters Corporation has a profit margin of 5.5 percent and its return on assets (investment) is 8.75 percent. What is its assets turnover? (Round your answer to 2 decimal places.)
  

b. If the Butters Corporation has a debt-to-total-assets ratio of 65.00 percent, what would the firm’s return on equity be? (Input your answer as a percent rounded to 2 decimal places.)
  

c. What would happen to return on equity if the debt-to-total-assets ratio decreased to 60.00 percent? (Input your answer as a percent rounded to 2 decimal places.)
  

Explanation / Answer

a) Profit Margin = (Net Income / Sales) x 100

Return on assets = (Net Income / Total assets) x 100

Asset Turnover = Sales / Total Assets

or, Assets Turnover = Return on assets / Profit Margin = 8.75% / 5.5% = 1.59 times

b) Debt + Equity = Total assets

Debt / Total assets = 65% or 0.65

Therefore, Equity / Total assets = 1 - 0.65 = 0.35

Return on Equity (ROE) = Net Income / Equity

Multiply numerator and denominator by Total Assets

or, ROE = (Net Income / Total assets) x ( Total assets / Equity)

or, ROE = (ROA) x [ 1 / 0.35 ] = 8.75% / 0.35 = 25.00%

c) Debt to total assets = 60% or 0.60

Equity to total assets = 1 - 0.60 = 0.40

ROE = 8.75% / 0.40 = 21.875% or 21.88%

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