Question

Using the table below, you are asked to calculate perform three-factor ROE decomposition (i.e. calculate ROE and its components) for all three of the following companies. What would you advise each company to do to improve its ROE? Discuss the specific component that needs to be improved and present an example of how it could done. Please round your answers to two decimal places.

	MTR	TKO	NRM
Sales	6,900	2,600	1,900
Net income	200	100	100
Average Assets	4,000	4,800	2,600
Average Equity	1,000	1,500	1,800
Average Liabilities	3,000	3,300	1,400

Answer 1

ROE =  profit margin * asset turnover * equity multiplier

profit margin = net income / sales

asset turnover = sales / average assets

Equity multiplier = average assets / average equity

The formulas are below

MTR

It is advised to improve profit margin to improve ROE. For example, this could be done by reducing expenses or increasing sale price

KTO

It is advised to improve profit margin and asset turnvover to improve ROE. For example, this could be done by increasing sale price or reducing excessive investment in assets.

NRM

It is advised to improve equity multiplier to improve ROE. For example, this could be done by increasing the proportion of debt in the capital structure