You observe that a firm's ROE is above the industry average, but its profit margin and debt ratio are both below the industry average. Which of the following statements is CORRECT?
A) its total assets turnover must equal the industry average.
B) its total assets turnover must be above the industry average.
C) its return on assets must equal the industry average.
D) its tie ratio must be below the industry average.
E) its total assets turnover must be below the industry average.

Question

Quizplus · Accepted Answer

Thinking through the DuPont equation, we can see that if the firm's PM and Equity multiplier are below the industry average, the only way its ROE can exceed the industry average is if its equity multiplier exceeds the industry average. The following data illustrate this point:
 $$\begin{array} { c c c c c c c c } 
&\mathrm { ROE } & = & \text { PM } & \text { x } & \text { TATO } & & \text { Eq mult } && \text { ROA } \
\text { Firm } & 30 \% & &9 \% && 2.0 && 1.67 & &18 \% \
\text { Industry } & 25 \% & &10 \% && 1 && 2.50 & &10 \%
\end{array}$$ 
The above demonstrates that b is correct, and that makes e and a incorrect. Now consider the following: NI/Assets = NI/Sales × Sales/Assets ROA = PM × TATO If its ROA were equal to the industry average, then with its low debt ratio (hence low equity multiplier) its ROE would also be below the industry average. So c is incorrect. With its debt ratio below the industry average, its interest charges should also be low, which would increase its TIE ratio, making d incorrect.

You Observe That a Firm's ROE Is Above the Industry