Question

A firm only uses debt and common stock to finance its operation. Its capital structure is 40% debt and 60% Equity. It reports NI of $900,000 and interest expense of $200,000. A firm's tax rate is 25%. Given ROA of 10%, what is its BEP?

1. 11.45% (this is incorrect)

2. 15.56%

3. 25.55%

4. 17.78%

A firm has an ROA of 50%, profit margin of 3% and ROE of 30%. What total asset turnover ratio?

1. 10x

2. 2.4x

3. 3.8x

4. 5x (this is incorrect)

Answer 1

Company's basic earning power (BEP) = Earnings before Interest and Taxes (EBIT)/ Total assets

Let’s first calculate the EBIT

We know that Net Income (NI) = $900,000

And Tax rate T = 25%

Therefore, EBT = EBIT / (1-T) = $900,000/ (1- 25%) = $1,200,000

Interest expenses are $200,000

Therefore, EBIT = EBT + Interest expenses = $1,200,000 + $200,000 = $1,400,000

Return on asset (ROA) = 10%

But ROA = Net Income/ Total Asset

Therefore, Total Asset = Net Income /ROA = $900,000/ 10% = $9,000,000

Therefore, Company's basic earning power (BEP) = $1,400,000/$9,000,000

= 0.1556 = 15.56%

Therefore correct answer is option: 15.56%

We know that

ROA = 50%

ROE = 30%

Profit margin =3%

We can use following DuPont equation to calculate Total assets turnover ratio

ROA = profit margin * total assets turnover ratio

50% = 3% * total assets turnover ratio

Or Total assets turnover ratio = 50% /3% = 16.67

Also

Equity Multiplier = ROE/ ROA = 30%/50% = 0.6

Now we know that

ROE = Profit margin * Total assets turnover * Equity multiplier

30% = 3% * Total assets turnover * 0.6

Or Total assets turnover = 30% / (3% * 0.6) = 16.67

Therefore no given option is correct, kindly check your answer again