Question

For fiscal year 2017, Costco Wholesale Corporation (COST) had a net profit margin of 2.08%, asset turnover of 3.55, and a book equity multiplier of 3.37. In the same fiscal year, Walmart Inc. had a ROE of 30.05%, a ROA of 15.20%, and a book value of equity of $1.8 Billion. a) Use this data to compute Costco's ROE using the DuPont Identity. [1 point] b) What is Walmart's book value of assets? What is Walmart's book debt-to-equity ratio? (assume that total debt includes all current and long-term liabilities) [2 points] c) If Costco's managers wanted to increase its ROE to match Walmart’s ROE, how much higher would their net profit margin need to be? Show how Costco could achieve a similar ROE by increasing asset turnover? [3 points] d) Costco's managers realize that they will be unable to increase asset turnover or net profit margin. Nonetheless, Costco's shareholders expect Costco to achieve a similar ROE as Walmart. How much would Costco's debt-to-equity ratio need to change to match Walmart's ROE? [4 points]

Answer 1

a). The DuPont Identity:

ROE = (Net Profit margin)*(Asset Turnover)*(Equity Multiplier)

ROE = 0.0208*3.55*3.37

ROE = 0.2488

ROE = 24.88%

b). Walmart ROE = 30.05%

ROE = (Net Income/Shareholder's Equity)*100

30.05 = (Net Income/$1.8 billion)*100

Net Income = $ 540.9 million

Walmart ROA = 15.20%

ROA = (Net Income/Total asset)*100

15.20 = (540.9 million/Total asset)*100

Total asset = $3558.55 million

So, Walmart's book Value of Asset = $ 3558.55 million

Total asset = Total equity + Total Liabilities

$3558.55 million = $ 1800 million + Total Liabilities

Total Liabilities = $1758.55 million

Walmart's Debt-to-Equity Ratio = Total Liabilities/Total Equities

= $1758.55 million/$1800 million

= 0.9770 times

c). Costco's ROE = 24.88%

Walmart's ROE = 30.05%

-- If Costco's managers needs to increase its ROE to match Walmart's ROE, the required profit margin would be

ROE = (Net Profit margin)*(Asset Turnover)*(Equity Multiplier)

0.3005 = Net Profit Margin*3.55*3.37

Net Profit Margin = 2.5118%

-- If Costco's managers needs to increase its Asset Turnover to match Walmart's ROE, the required profit margin would be

ROE = (Net Profit margin)*(Asset Turnover)*(Equity Multiplier)

0.3005 = 0.0208*Asset Turnover*3.37

Asset Turnover = 4.2870

d). Since, Costco is not able to increase Asset Turnover or net profit margin to match Walmart's ROE, the Equity Multiplier they needs to increase to match Walmart's ROE

ROE = (Net Profit margin)*(Asset Turnover)*(Equity Multiplier)

0.3005 = 0.0208*3.55*Equity Multiplier

Equity Multiplier = 4.0696

Equity Multiplier =Total Assets/Total equity

Debt-to-Equity ratio = Total Liabilities/Total Equities

= (Total Assets - Total Equities)/Total Equities

= (Total Assets/Total Equities) - (Total Equities/Total Equities)

= Equity Multiplier - 1

= 4.0696 - 1

= 3.0696

So, Costco's Debt Equity Ratio needs to 3.0696 times to match Walmart's ROE

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