Question

Wei and Bo are two retailers that have the same ROE for one year. Here is the basic three-factor DuPont data:

Ratio	Wei	Bo
Profit Margin	40%	10%
Total Asset Turnover	0.5	12
Financial Leverage	3	0.5

A. Wei may have a higher cost of goods (inferior cost control), all else equal.

B. All else equal, Bo has higher interest burden.

C. All else equal, Wei may have higher sales volume.

D. When economy is bad, the leverage ratio suggests Wei may have cash flow problem.

Answer 1

Explanations is given below

Answer is Option D) Explanations: A Wei does not have higher Cost of goods sold, because its Profit margin is 40% and hence its has low Operating cost B Bo does not have high interest burden because its financial leverage is lower Financial leverage is calculated Operating profit before interest and taxes / Operating profit after taxes Higher the Financial leverage higher is the interest burden C Wei does not have higher sales volume because its Asset turnover ratio is lower D Leverage ratio of Wei will pose cash flow problem due to its high leverage. High leverage indicates high component of interest cost. Hence if economy is doing bad and Sales dip payment of fixed interest cost will lead to cash flow problem