Question

11) Consider a retail firm with a net profit margin of 3.5%, a total asset turnover of 1.8, total assets of $44 million, and a book value of equity of $18 million. a. What is the firm's current ROE? b. How does it compare with Macy's data for 2018? c. If the firm increased its net profit margin to 4%, what would its ROE be?

Answer 1

11)a. Calculation of firm's current ROE

ROE = Net Income / Equity

We have been provided with Equity as per books of 18 Million $ in the question, hence we now need to calculate the Net Income

Calculation of Net Income :

Total Assets Turnover = Net Sales / Total Assets = 1.8

Net Sales / 44$ Million = 1.8

Net Sales = 79.2 Million $

Net Profit Margin = Net Income / Net sales = 3.5%

Net Income / 79.2 Million $ = 3.5%

Net Income = 2.772 Million $

Hence, ROE = 2.772 / 18 = 15.4 %

11)b. Calculation of Macy's ROE for 2018

ROE = Net Income / Equity

ROE = 1108/6436 = 17.22%

Important Note : When NCI is given in the question, it is important to ensure that the numerator and denominator base for ROE calculation are consistent, i.e., they are both either including the NCI figures or are excluding the same. In the current case, we have excluded the NCI figures and hence we have taken Net Income as 1,108 instead of 1,098.

Now we have the following ROE figures for both the companies :

Firm

ROE

Retail firm

15.40%

Macy

17.22%

Now to understand which firm has a better ROE and is in a better position, we first need to understand what ROE indicates.

ROE is a profitability ratio which basically measures the entity's ability to generate profits from the investment made by shareholders in the company.

Hence a higher ROE indicates the entity's ability to generate higher profits without needing much of shareholder's investment which is very good.

Hence from the above discussion, we can conclude that higher ROE is always better. Hence since Macy's ROE is greater than retail firm's ROE, we can say that Macy is in a better position as compared to the retail firm.

11)c. Calculation of ROE if profit margin increased to 4%

Since profit margin is now 4%, Net income = 4% of sales as calculated in 11)a. above

Hence, Net Income = 4% of 79.2 Million $ = 3.168 Million $

Hence, ROE = 3.168 / 18 = 17.6%

Hence we can observe that as the Net income increases, the ROE has also increased. It is even better than the ROE calculated for Macy in 2nd part above.