Chapter 19, Problem 2CP

Summary Introduction

(A)

Adequate information:

Net Profit - $510

Pretax Profit - $805

EBIT - $830

Sales - $5140

Assets - $3100

Equity - $2200

To identify and calculate five components that determines Du Pont Formula

Introduction:

In Du-pont system, the return on equity is decomposed into five components which are tax burden, interest burden, profit margin, assets turnover and leverage. Thus decomposed return on equity is calculated as:

Return on Equity = Net profit Pretax profit EBIT Sales Assets

__________ × __________ × _____ × _____ × _______

Pretax profit EBIT Sales Assets Equity

= Tax burden × Interest burden × Margin × Turnover × Leverage

Summary Introduction

(B)

Adequate information:

Net Profit - $510

Pretax Profit - $805

EBIT - $830

Sales - $5140

Assets - $3100

Equity - $2200

To calculate Return On Equity(ROE) for 2019 using components of Du Pont Formula.

Introduction:

Return on Equity measures the financial performance of the company by focussing only on the profitability of equity investments. It is expressed as:

  $\text{Return on Equity=}\frac{\text{Net Income}}{\text{Shareholders equity}}$

Though in Du-pont system, the return on equity is decomposed into five components. Thus decomposed return on equity is calculated as:

  $\begin{array}{l}\text{ReturnonEquity = }\frac{\text{Netprofit}}{\text{Pretaxprofit}}\text{×}\frac{\text{Pretaxprofit}}{\text{EBIT}}\text{×}\frac{\text{EBIT}}{\text{Sales}}\text{×}\frac{\text{Sales}}{\text{Assets}}\text{×}\frac{\text{Assets}}{\text{Equity}}\\ \text{= TaxBurden×InterestBurden×Margin×Turnover×Leverage}\end{array}$

Summary Introduction

(C)

Adequate information:

Net Profit - $510

Pretax Profit - $805

EBIT - $830

Sales - $5140

Assets - $3100

Equity - $2200

Dividend per share - 0.60

Earnings Per Share(EPS)- $1.96

To calculate the firm's sustainable growth rate for 2019 from firm's ROE and plowback ratios.

Introduction:

The sustainable growth is the maximum growth rate that a firm can sustain without having to lookout for outside finance. It is multiple of return on equity and retention ratio. It is calculated as:

Sustainable Growth rate = Return on equity * Plowback ratio