Question

Consider a retail firm with a net profit margin of ​, a total asset turnover of ​, total assets of ​million, and a book value of equity of million. a. What is the​ firm's current​ ROE? b. If the firm increased its net profit margin to ​, what would be its​ ROE? c.​ If, in​ addition, the firm increased its revenues by ​(maintaining this higher profit margin and without changing its assets or​ liabilities), what would be its​ ROE?

Answer 1

Answer:

a. 15.62%

b. 17.79%

c. 21.53%

Explanation:

a. The Dupont formula for calculating Return on Equity is useful here;

ROE = Net Profit margin * Asset Turnover * Assets / Equity

ROE = 3.6% * 1.88 * ( 43.4/18.8)

ROE = 15.62%

b. ROE = Net Profit margin * Asset Turnover * Assets / Equity

= 4.1% * 1.88 * ( 43.4/18.8)

= 17.79%

c. As a result of the increase in revenues, the asset turnover will increase by;

= Asset turnover * ( 1 + increase in revenue)

= 1.88 ( 1 + 21%)

= 2.2748‬

ROE = 4.1% * 2.2748 * ( 43.4/18.8)

= 21.53%