Question

Ratios:

Current Ratio: 3.6093

Quick Ratio:                           2.1799

Times Interest Earned: 9.9143

ROE                                        16.48%

ROA                                        12.01%

Equity Multiplier                    1.3714

Inventory Turnover 1.3489

The DuPont Identity helps us to better understand why a firm might have a poor ROE (Return on Equity).  We can write the DuPont Identity as follows:

ROE = (Net Income / Sales)(Sales / Assets)(Assets / Owner's Equity)

Based on this, which of the following statements are true?

Select one:

a. If Sales remained constant but Net Income fell, the ROE would rise, ceteris paribus (all else remaining equal)

b. If Sales remained constant but the firm sold off half of its Assets, the ROE would rise, ceteris paribus (Assume that the Equity Multiplier remains constant)

c. If Assets remain constant but Owner’s Equity goes up, the ROE would rise, ceteris paribus.

d. All of the above statements are true

e. None of the above statements are true.

Answer 1

Answer) Option B) If Sales remained constant but the firm sold off half of its Assets, the ROE would rise, ceteris paribus

The DU Pont Analysis helps us to analyse the components of ROE.

As per the DU Pont Analysis , ROE = (Net Income / Sales) * (Sales / Assets) * (Assets / Owner's Equity)

Option a) is incorrect because if sales remain constant and Net Income falls, the ROE will fall.

Option b) is correct because if assets reduce by half , the ROE will rise. This is because Equity = Assets - Liab.

A fall in assets will lead to a fall in equity. With a fall in equity and constant sales, the Return on Equity will increase.

Option c) is incorrect because if assets remain constant and equity increases (due to reduction in liab), then the equity base will be higher with same net income which will lead to a fall in return on equity,

Option d) is incorrect because all of the above statements are not true. option c) and option a) are incorrect.

Option e) is incorrect because statement b) is true.