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4. The DuPont System allows us to relate the return on total assets and the return...

4. The DuPont System allows us to relate the return on total assets and the return on common equity to various measures of firm characteristics. Consider a firm with a ROA of 0.04.
a. If you were analyzing a firm that had sales of $12500 and total assets of $10000, how much in earnings were available for common shareholders?

b.If the firm had common stockholders' equity of $3300, what would be the firm's ROE?

c. If we compare this firm to another similar firm in the industry we find that the comparison firm has an ROA and ROE of 0.05 and 0.191663, respectively. Given this information, calculate the comparison firm's ratio of total assets to common stock equity. How does this ratio differ from our firm?

d.Interpret the performance differences between these firms.

Expert Solution

Answer (a):

Total assets = $10000

ROA = 0.04

ROA = Net Income /Total assets

=>Net Income = ROA * Total assets = 0.04 * 10000 = $400

Hence:

Earnings were available for common shareholders = $400

Answer (b):

ROE = Earnings were available for common shareholders / Equity = 400 / 3300 = 12.12%

ROE = 12.12%

Answer (c):

Comparison firm has:

ROA = 0.05 and

ROE = 0.191663

ROA = Net Income /Assets

=> Net Income = ROA * Assets

ROE = Net Income /Equity = ROA * Assets / Equity

=> Assets / Equity = ROE / ROA = 0.191663 / 0.05 = 3.83

Comparison firm's ratio of total assets to common stock equity = 3.83

Our firm's ratio of total assets to common stock equity = 0.1212 / 0.04 = 3.03

As such comparison firm has higher ratio of total assets to common stock equity as compared to our firm

Answer (d):

In terms of both ROA and ROE comparison firm is performing better as compared to our firm.

Further comparison firm has higher ratio of total assets to common stock equity as compared to our firm.

As comparison firm has better ROA, it is managing its assets more efficiently as compared to our firm.

Further comparison firm's higher ratio of total assets to common stock equity indicates that its financial leverage is higher as compared to our firm.

jeff jeffy answered 1 month ago

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