Question

Use the following information for corporate firms:

Net profit margin = 0.1, equity multiplier=2, and return on equity = 0.1

1. Using the Dupont identity, find the asset turnover ratio.

2. Complete the following table. Hint: you need to use the information and formulas above.

Items	Values
Total Assets	1,000,000
Equity
Sales
Net income

c.) Comment if the ratios seems to be in reasonable zone and whether they seem low or high

Answer 1

(a): As per the Dupont identity we have: return on equity = net profit margin * equity multiplier * asset turnover ratio

Thus 0.1 = 0.1 * 2 * asset turnover ratio

or asset turnover = (0.1/0.1*2) = 0.50

Thus asset turnover = 0.50

(b): Asset turnover = sales/total assets. Thus 0.50 = sales/1,000,000. Or sales = 1,000,000*0.50 = $500,000

Equity multiplier = assets/equity. Thus 2 = 1,000,000/equity. Or equity = 1,000,000 = 500,000

Net profit margin = net profit/sales. Thus 0.1 = net profit/500,000. Thus net profit = 0.1*500,000 = 50,000

Items	Values
Total assets	1,000,000
Equity	500,000
Sales	500,000
Net income	50,000

(c ): The ratios seems to be in reasonable zone. Net profit percentage of 10% (or 0.1) is a reasonably good net profit margin for a company. Return on equity of 10% (or 0.1) is also reasonably good. Equity multiplier of 2 indicates that total assets is twice of equity and hence this indicates that total liability of the company = total equity of the company. In other words the company’s debt-equity ratio is 1. This shows that the company is leveraged but not only leveraged. Asset turnover of 0.50 seems to be low but its true interpretation will depend on the type of industry this company is operating in.