Question

So given your knowledge of the component ratios used in the DuPont equation, which of the following strategies should improve the company’s ROE? Check all that apply.(A) Increase the firm’s bottom-line profitability for the same volume of sales, which will increase the company’s net profit margin.(B) Decrease the amount of debt financing used by the company, which will decrease the total asset turnover ratio.(C) Decrease the company’s use of debt capital because it will decrease the equity multiplier.(D) Increase the efficiency of its assets so that it generates more sales with each dollar of asset investment and increases the company’s total asset turnover.

Answer 1

Answer:

(A) Increase the firm’s bottom-line profitability for the same volume of sales, which will increase the company’s net profit margin.

(D) Increase the efficiency of its assets so that it generates more sales with each dollar of asset investment and increases the company’s total asset turnover.

Explanation:

Return on Equity is measured as the total return available for equity, or total value for equity.

Each increase in net profit will increase the return on equity, as that is the share for equity only.

Similarly when there is increase in efficiency of the assets to generate more sales and accordingly more revenue with the same amount of investment, this will increase the return on equity.

Return on Equity is basically measured through three parameters:

• Operating efficiency which is basically the operating profit generated.
• Asset usage, that means the total assets used for the output.
• Financial leverage which is calculated through value of equity and assets, there is no significance of debt in it.

Therefore, the valid statements in this context are:

Statement (a) and (d)