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CA Final · Financial Reporting · Analysis of Financial Statements

Tulsi Pharma Ltd: net profit margin 8%, total asset turnover 1.5 times, and equity multiplier (average total assets / average equity) 2.0. In the next year, the margin falls to 6% and asset turnover rises to 2.0 times, while the equity multiplier rises to 2.5. Using the DuPont three-step model, what is the change in ROE?

ROE rises from 24% to 30%. Under DuPont, ROE equals net margin times asset turnover times equity multiplier. Year one gives 8% x 1.5 x 2.0 = 24%, and year two gives 6% x 2.0 x 2.5 = 30%, so higher turnover and leverage outweigh the lower margin.

  1. AIncreases from 24% to 30%Correct
  2. BIncreases from 12% to 30%
  3. CDecreases from 24% to 18%
  4. DIncreases from 24% to 25%

Explanation

Year 1 ROE = 8% x 1.5 x 2.0 = 24%. Year 2 ROE = 6% x 2.0 x 2.5 = 30%. So ROE increases by 6 percentage points. The 12% option omits the equity multiplier in year 1 (8% x 1.5), mixing bases; the 18% option wrongly assumes falling margin dominates.

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