Question

John company has the following information:

Operating profit = $2,500, Sales = $6,000, Total assets turnover = 2.5, Applicable tax rate = 20%, the company is 100% equity financed.

Find: ROE, Net profit margin.

Answer 1

First we will calculate total assets as per below:

Total assets turnover = Sales / Total assets

Putting the given values in the above formula, we get,

2.5 = $6000 / Total assets

Total assets = $6000 / 2.5

Total assets = $2400

Since, the firm is 100% equity financed, so following the accounting equation (i.e. Assets = Debt + Equity), equity will be same as assets:

Equity = Total assets = $2400.

Next, we will calculate net income:

Net income = Operating profit * (1 - tax rate)

Net income = $2500 * (1 - 0.2)

Net income = $2500 * 0.8

Net income = $2000

Now. Return on equity (ROE) is :

Return on equity (ROE) = Net income / Equity * 100

Return on equity (ROE) = $2000 / $2400 * 100

Return on equity (ROE) = 83.33%

Net profit margin is :

Net profit margin = Net income / Sales * 100

Net profit margin = $2000 / $6000 * 100

Nety profit margin = 33.33%