spartan1

Given the following information about a firm what is its return on equity (ROE)?

• An asset turnover of 1.2.
• An after tax profit margin of 10%.
• A financial leverage multiplier of 1.5.

A) 0.18.

B) 0.09.

C) 0.12.

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ROE = (EAT / S)(S / A)(A / EQ)
ROE = (0.1)(1.2)(1.5) = 0.18

spartan1

With other variables remaining constant, if profit margin rises, ROE will:

A) fall.

B) increase.

C) remain the same.

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The DuPont equation shows clearly that ROE will increase as profit margin increases, as long as asset turn and leverage do not fall.

spartan1

If a company has a net profit margin of 15%, an asset turnover ratio of 4.5 and a ROE of 18%, what is the equity multiplier?

A) 0.267.

B) 2.667.

C) 0.523.

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There are many different ways to illustrate ROE one of which is:
ROE = (net profit margin)(asset turnover)(equity multiplier)
0.18 = (0.15)(4.5)(equity multiplier)
0.18 ÷ [(0.15)(4.5)] = equity multiplier
0.18 ÷ 0.675 = equity multiplier
0.18 ÷ 0.675 = 0.267

spartan1

When the return on equity equation (ROE) is decomposed using the original DuPont system, what three ratios comprise the components of ROE?

A) Net profit margin, asset turnover, asset multiplier.

B) Net profit margin, asset turnover, equity multiplier.

C) Gross profit margin, asset turnover, equity multiplier.

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The three ratios can be further decomposed as follows:
Net profit margin = net income/sales
Asset turnover = sales/assets
Equity multiplier = assets/equity

spartan1

Which of the following ratios is NOT part of the original DuPont system?

A) Asset turnover.

B) Debt to total capital.

C) Equity multiplier.

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The debt to total capital ratio is not part of the original DuPont system. The firm’s leverage is accounted for through the equity multiplier.

spartan1

Would an increase in net profit margin or in the firm’s dividend payout ratio increase a firm’s sustainable growth rate?

Net profit margin

Dividend payout ratio

A) Yes Yes

B) Yes No

C) No No

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The sustainable growth rate is equal to ROE multiplied by the retention rate. According to the Dupont formula, an increase in net profit margin will result in higher ROE. Thus, an increase in net profit margin will result in a higher growth rate. The retention rate is equal to 1 minus the dividend payout ratio. Thus, an increase in the dividend payout ratio will lower the retention rate and lower the growth rate.

dkishore1

An analysis of the industry reveals that firms have been paying out 45% of their earnings in dividends, asset turnover = 1.2; asset-to-equity (A/E) = 1.1 and profit margins are 8%. What is the industry’s projected growth rate?

A) 5.81%.

B) 4.55%.

C) 4.95%.

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ROE = profit margin × asset turnover × A/E = 0.08 × 1.2 × 1.1 = 0.1056
RR = (1 - 0.45) = 0.55
g = ROE × RR = 0.1056 × 0.55 = 0.0581

dkishore1

McQueen Corporation prepared the following common-size income statement for the year ended December 31, 20X7:

Sales	100%
Cost of goods sold	60%
Gross profit	40%

For 20X7, McQueen sold 250 million units at a sales price of $1 each. For 20X8, McQueen has decided to reduce its sales price by 10%. McQueen believes the price cut will double unit sales. The cost of each unit sold is expected to remain the same. Calculate the change in McQueen’s expected gross profit for 20X8 assuming the price cut doubles sales.

A) $150 million increase.

B) $80 million increase.

C) $50 million increase.

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20X7 gross profit is equal to $100 million ($1 × 250 million units sold × 40% gross profit margin). The 10% price cut to $0.90 will increase cost of goods sold to 67% of sales [COGS=0.6($1) = $0.60; $0.60 / $0.90 = 67%.]. As a result, gross profit will decrease to 33% of sales. If unit sales double in 20X8, gross profit will equal $150 million ($0.90 × 500 million units × 33% gross profit margin). Therefore, gross profit will increase $50 million ($150 million 20X8 gross profit – $100 million 20X7 gross profit).

dkishore1

Lightfoot Shoe Company reported sales of $100 million for the year ended 20X7. Lightfoot expects sales to increase 10% in 20X8. Cost of goods sold is expected to remain constant at 40% of sales and Lightfoot would like to have an average of 73 days of inventory on hand in 20X8. Forecast Lightfoot’s average inventory for 20X8 assuming a 365 day year.

A) $8.0 million.

B) $22.0 million.

C) $8.8 million.

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20X8 sales are expected to be $110 million [$100 million × 1.1] and COGS is expected to be $44 million [$110 million sales × 40%]. With 73 days of inventory on hand, average inventory is $8.8 million [($44 million COGS / 365) × 73 days].

dkishore1

In preparing a forecast of future financial performance, which of the following best describes sensitivity analysis and scenario analysis, respectively?Description #1 – A computer generated analysis based on developing probability distributions of key variables that are used to drive the potential outcomes.
Description #2 – The process of analyzing the impact of future events by considering multiple key variables.Description #3 – A technique whereby key financial variables are changed one at a time and a range of possible outcomes are observed. Also known as “what-if” analysis.

Sensitivity analysis

Scenario analysis

A) Description #3 Description #2

B) Description #3 Description #1

C) Description #2 Description #3

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Sensitivity analysis develops a range of possible outcomes as specific inputs are changed one at a time. Sensitivity analysis is also known as “what-if” analysis. Scenario analysis is based on a specific set of outcomes for multiple variables. Computer generated analysis, based on developing probability distributions of key variables, is known as simulation analysis.