Question

Based on the information below, which of the following statements is most likely correct?

Profit margin Asset turnover Equity multiplier Return on equity (ROE)

Firm A 1.14 3.2 1.2 4.38

Firm B 1.14 3.1 1.9 6.71

Firm B's higher leverage seems to have engineered its ROE to be higher than Firm A's.

Although Firm B's ROE is higher, its profit margin and asset turnover suggest that Firm A has been a lot more efficiently operating company in terms of managing expenses and assets.

We can conclude that Firm B has been a more profitable and efficient firm based on the comparison of the ROEs.

Answer 1

Solution:

Wecan understand this question with help of DU-Pont Anaysis. This Du-pont Analysis is used to evaluate the component parts of company's return on equity. In order to decide which company is better investor decides to use du-pont analysis to which company is going to improve its ROE .

Formula to calculate ROE is :

Net Profit margin*Assest Turnover Ratio*Equity multiplier

1.14*3.2*1.2=4.38 ROE A

2.14*3.1*1.9=6.71 ROE B

There is direct relationship between ROE and Equity Multiplier. Any increase in the value of of equity multiplier shows that company incurs hiher level of debt in its capital structure nd has lower overall cost of capital. so we can conclude from du pont anyalysis B firm has Greater ROE in comparison of A