Question

Travel Corp. has net income of $2 million, an effective tax rate of 35%, interest expense of $400,000, sales of $30 million, and $15 million in total assets, of which $5 million is debt. Use the DuPont system to calculate its ROE, decomposed into leverage ratio, asset turnover, profit margin, and debt burden.

profit margin = ??

asset turnover = ??

equity multiplier = ??

return on equity = ??

Answer 1

Profit Margin

Profit Margin = (Net Income / Sales) x 100

= ($20,00,000 / $300,00,000) x 100

= 6.67%

Asset Turnover

Asset Turnover = Sales / Total Assets

= $300,00,000 / $150,00,000

= 2 Times

Equity Multiplier

Equity Multiplier = 1 + Debt/Equity Ratio

Debt = $50,00,000

Equity = Total Assets – Total Debt

= $150,00,000 - $50,00,000

= $100,00,000

Debt/Equity Ratio = Total Debt / Total Equity

= $50,00,000 / $100,00,000

= 0.50

Therefore, the Equity Multiplier = 1 + Debt/Equity Ratio

= 1 + 0.50

= 1.50

Return on Equity

As per DuPont Model, Return on Equity [ROE] = Profit Margin x Total Asset Turnover x Equity Multiplier

Return Equity = 6.67% x 2 Times x 1.50

= 20%