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NISM Certifications · NISM-Series-XV: Research Analyst · Company Analysis - Financial Analysis

Data for Sunrise Ltd: net profit margin 5%, asset turnover 2.0 times, and equity multiplier 2.5. Using the DuPont identity, what is ROE? If the margin rose to 6% with other factors unchanged, what would ROE become?

ROE equals 5% x 2.0 x 2.5, which is 25%. When margin increases to 6% with other factors constant, ROE becomes 6% x 2.0 x 2.5, which is 30%. Leaving out leverage would understate ROE.

  1. A25% rising to 30%Correct
  2. B10% rising to 12%
  3. C12.5% rising to 15%
  4. D25% rising to 36%

Explanation

ROE = margin x asset turnover x equity multiplier = 0.05 x 2.0 x 2.5 = 25%. With 6%: 0.06 x 2.0 x 2.5 = 30%. Omitting the equity multiplier gives 10% and 12%, a common error.

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