Question

Calvert Corp. has sales of $100 million, assets of $75 million, and liabilities of $25 million. Its managers decide that they can focus on increasing its profit margin to match the industry’s ROE. The industry profit margin is 10%, total asset turnover is 1.2, and equity multiplier is 1.8. What is the target profit margin for Calvert Corp.?

Answer 1

Industry ROE using Dupont analysis is computed as = Profit margin* Asset turnover * Equity multiplier

( i.e. Net profit/ Sales*100*sales/ Assets*Assets/Equity or Net profit / Equity *100)

=10%*1.2*1.8

=21.6%

For Calvert corp

Asset turnover = Sales/ Assets= 100million/75 Million= 1.3333

Given Liabilites = 25

We know that

Total Assets = Liabilites + equity

75 Million= 25 Million + equity

Equity = 50 Million

Equity multiplier = Assets/ Equity

Hence Equity multiplier= 75/50= 1.5

For calvert corp

Required ROE = Industry ROE

Hence Required ROE = 21.6%

Profit margin* Asset turnover *Equity multiplier= 21.6%

Profit margin*1.3333*1.5=21.6%

Profit margin= 21.6%/(1.3333*1.5)

=21.6%/2

= 10.80%

hence target Profit margin = 10.80%