Question

DuPont Analysis

a) Bate Industries has a quick ratio of 1.3, net profit margin of 6%, inventory turnover of 2.8, total asset turnover of 1.5, accounts receivable turnover of 2.2, a debt-to-equity ratio of 1.1, and its PE ratio is 18. (1) Find the firm’s equity multiplier (2) Compute ROE

b) Bate Industries has net income of $192 million on sales of $960 million. Bate has $320 million in Debt with $1.6 Billion in Assets. The firm has a beta of 1.1 and its required return is 12.9%. The market recently returned 14% and T-bills are earning 2% (1) Find the firm’s equity multiplier (2) Compute ROE

Answer 1

1. For DuPont Analysis,

ROE = (Net Income / Sales) * (Sales / Assets) * (Assets / Equity)

As per the given data, we have net profit margin i.e. Net income / sales

we have Asset turnover i.e. Sales / Assets

We don't have equity multiplier i.e. Assets / Equity. However, we have Debt to Equity Ratio, now assuming no other liabilities like pension or prepayment. We can assume safely that Total Assets = Total Debt + Total Equity

we have Debt / Equity = 1.1

using Debt = Asset - Equity, we have (Asset - Equity) / Equity = 1.1

which gives Asset / Equity - 1 = 1.1 imples Asset / Equity = 2.1 (equity multiplier)

Hence, now we have all the multipliers for ROE

ROE = 6% * 1.5 * 2.1 = 18.9%

Question 2

Similarly, here, we have total assets = $1600mm and Debt = $320

Since, Equity = Asset - Debt = 1600-320

Equity = 1280

Equity Multiplier = 1600 / 1280 = 1.25

Now, ROE = (192/960) * ( 960/1600) * (1600/1280)

ROE = 20% * 0.6 * 1.25 = 15%