A firm has a (net profit/pretax profit) ratio of 0.6, a leverage ratio of 2, a (pretax profit/EBIT) of 0.6, an asset turnover ratio of 2.5, a current ratio of 1.5, and a return on sales ratio of 4%.The firm's ROE is
A)4.2%.
B)5.2%.
C)6.2%.
D)7.2%.

Question

Quizplus · Accepted Answer

The firm's Return on Equity (ROE) can be calculated using the Dupont Identity, which breaks down ROE into three components: Net Profit Margin, Asset Turnover, and Equity Multiplier. Given the information:1. Net Profit Margin = Net Profit / Sales. Since the Return on Sales (net profit/sales) is 4%, the Net Profit Margin is 4%.2. Asset Turnover = Sales / Assets. Given as 2.5.3. Equity Multiplier = Assets / Equity. Given the leverage ratio (assets/equity) as 2, the Equity Multiplier is 2.ROE = Net Profit Margin * Asset Turnover * Equity Multiplier= 4% * 2.5 * 2= 0.04 * 2.5 * 2= 0.20 or 20%However, the provided choices do not directly match this calculation, suggesting a misunderstanding in the calculation process. Given the ratios and the correct application of the Dupont Identity, the correct approach to find ROE involves understanding the relationships between the given ratios and how they affect the ROE calculation. The provided ratios and the calculation method do not directly lead to the options given, indicating a need for clarification in the calculation steps or the provided information.Re-evaluating the calculation with a focus on the provided ratios and their direct impact on ROE:- The (net profit/pretax profit) ratio of 0.6 and a (pretax profit/EBIT) of 0.6 indicate how much of the EBIT is retained as net profit after taxes and interest. However, without direct profit or EBIT values, these ratios need to be integrated with the leverage and asset turnover ratios to estimate ROE.- The leverage ratio of 2 indicates the firm uses debt to finance its assets twice as much as equity, which impacts ROE by potentially increasing it due to the use of debt.- The asset turnover ratio of 2.5 indicates the efficiency of the firm in generating sales from its assets.- The current ratio and return on sales provide liquidity and profitability insights but are not directly used in the basic ROE calculation through the Dupont Identity.Given the misunderstanding in the initial explanation and the lack of direct application of the provided ratios to the Dupont Identity formula, the correct answer should reflect an understanding of how these ratios influence ROE. However, without explicit financial figures or a clear path from the given ratios to the ROE calculation, the selection of the correct answer from the provided choices (A, B, C, D) based on the initial explanation is challenging and likely incorrect. The correct approach involves a detailed calculation integrating all provided ratios, which was not accurately captured in the initial response.

A Firm Has a (Net Profit/pretax Profit) Ratio of 0