Question

Question 14

The DuPont Identity holds that ROE = PM x T/A T/O x EM. However, after doing some quick algebra, ROE still equals net income divided by owner’s equity. What does the DuPont Identity accomplish with its expansion of the ROE into profit margin, total asset turnover and equity multiplier components?

The identity allows expanding the ROE into the aftertax income.

The identity uses the ROE in describing such things as the costs of Obamacare.

The identity can reveal the impact of new borrowing on employee morale.

The identity separates the ROE into operating, capital budgeting and capital structure components.

The identity is used by bankers in meeting capital requirements under the Dodd Frank Act.

Question 15

A firm’s current market value of equity is $20 million. It has one million shares outstanding. The firm’s equity multiplier is one, and it had sales of $50 million last year. Its profit margin was 5%. What is the firm’s implied price-earnings ratio?

40

5

16

20

8

Question 16

If you deposit $2,000 into an account at the end of each of the next 40 years, at 4.5% interest, how much will you have in the account, to the nearest $1,000, in 40 years?

$184,000

$214,000

$63,000

$122,000

$196,000

Question 17

Your company had net sales of $100,000 over the past year. Half the sales were credit sales. During that time, average receivables were $5,000. What was the average collection period? (Assume a 360-day year)

18 days

27 days

36 days

72 days

60 days

Answer 1

Question 14]

To calculate directly, ROE = net income / equity

As per DuPont equation, ROE = (net income / sales) / (sales / total assets) * (total assets / equity)

Thus, the DuPont equation breaks up ROE into three components or drivers - net profit margin, total asset turnover, and equity multiplier. Net profit margin measure operational efficiency, total asset turnover measures efficiency of usage of assets, and equity multiplier measures financial leverage. Thus, the ROE is broken up into operating, capital budgeting and capital structure components.

The fourth statement is correct.

The first statement is incorrect - The identity allows expanding the ROE into the aftertax income margin, total asset turnover, and equity multiplier.

The second statement is incorrect - The Dupont equation is irrelevant in describing such things as the costs of Obamacare

The third statement is incorrect - It is irrelevant in measuring employee morale

The fifth statement is incorrect - It is not a capital adequacy ratio