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CA Intermediate · Financial Management and Strategic Management · Financial Analysis and Planning - Ratio Analysis

A firm has net profit margin of 5%, total asset turnover of 2 times and equity multiplier (total assets/equity) of 1.8. Using the DuPont identity, its return on equity is:

Under the DuPont identity, ROE equals net margin times asset turnover times equity multiplier: 5% x 2 x 1.8 = 18%. The 10% figure is merely return on assets and ignores the effect of financial leverage on shareholders' returns.

  1. A10%
  2. B18%Correct
  3. C9%
  4. D12.6%

Explanation

ROA = 5% x 2 = 10%. ROE = ROA x equity multiplier = 10% x 1.8 = 18%. Check: ROE 18% with equity multiplier 1.8 gives ROA 10%. The 10% option is only ROA, ignoring leverage.

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