Question

A company has a return on equity of 10% and a return on assets of 2%. What is its Debt-to-equity ratio? (Hint: Review the DuPont analysis and you can assume total debt = total liabilities for this problem)
4.0
8.0
1.20
3.0
5.0

Answer 1

Net income/ equity = 10%

Net income / assets = 2%

Assets/ Equity = Net income/ Equity * Assets/ Net income

= 10*1/2

= 5.0

Asset equity ratio = 5.0 and as per the assumption total debt = Total liabilities therefore total assets is 5 times the equity which means that the remaining 4 parts of the liabilities side of the balance sheet consist of 2 part each of debt and liabilities.

In other words we can say that assets have 5 parts and against it 1 part is equity , 2 parts are debt and 2 parts are liabilities.

Therefore debt equity ratio

= ( Total debt + Total liabilities)/ Total equity

= (2 + 2 )/1

= 4/1

= 4.0

Therefore the correct option is 1st.