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) 2.9%
B) 4.3%
C) 7.2%
D) 15.0%
E) none of these

Question

Quizplus · Accepted Answer

ROE = net profit/total equity 
= (net profit/pre-tax profit) x (pre-tax profit/EBIT) x (EBIT/total assets) x (total assets/total equity) 
= 0.6 x 0.6 x 2.5 x 0.5 
= 0.45 or 45% 
However, we need to consider leverage ratio, 
ROE = 0.45 x 2 
= 0.9 or 9% 
Finally, we need to adjust for the current ratio and return on sales ratio, 
ROE = 0.9 x (1 - 0.04) x (1 - 1/1.5) 
= 0.72 or 7.2%.

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