CFA Level I · CFA Level I Exam · Company Analysis: Past, Present, and Future
Company X reports the following for Year 2: sales 500, net income 40, average total assets 400, average equity 160. Using the three-part DuPont decomposition, Company X's return on equity is closest to:
Return on equity is closest to 25.0%. Net margin is 8%, asset turnover is 1.25 and financial leverage is 2.5, and their product is 25%. This matches net income of 40 divided by average equity of 160. The 10% figure is return on assets, which omits leverage.
- A10.0%
- B25.0%Correct
- C31.3%
Explanation
Net margin = 40/500 = 8%. Asset turnover = 500/400 = 1.25. Leverage = 400/160 = 2.5. ROE = 0.08 x 1.25 x 2.5 = 25.0%. Check: 40/160 = 25.0%. The 10.0% figure is ROA (40/400), which ignores leverage.
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