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 8 percent and its return on assets (investment) is 17.75 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 30.00 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 25.00 percent? (Input your answer as a percent rounded to 2 decimal places.)

Answer 1

Answer:

Part a = 2.22 %

Part b = 25.36%

Part c = 23.67%

Explanation:

The Du Pont method is that method which defines the return on equity into three parts that includes gross profit margin, asset turnover, and financial leverage.

The profit margin and asset turnover show the relation with sales revenue whereas the financial leverage show a ratio of debt and shareholder equity.

a. Asset turnover : In duo Pont method,the asset turnover formula :

= Return on Assets ÷ Profit margin

= 17.75% ÷ 8%

= 2.22 %

b. The Return on equity is equal to

= Return on assets ÷ (1 - debt to total assets ratio)

= 17.75% ÷ (1-0.30)

= 25.36%

c. Applying same formula which is used in part b

Return on equity = Return on assets ÷ (1 - debt to total assets ratio)

= 17.75% ÷ (1 - 0.25)

= 17.75% ÷ 0.75

= 23.67%

Hence,  Part a = 2.22 %

Part b = 25.36%

Part c = 23.67%