Shouldn’t ROE be 50% instead of 30%?. Please see Schweser question below. Given the following information, compute the implied dividend growth rate. * Profit margin = 10.0% * Total asset turnover = 2.0 times * Financial leverage = 1.5 times * Dividend payout ratio = 40.0% A) 4.5%. B) 12.0%. C) 18.0%. Your answer: B was incorrect. The correct answer was C) 18.0%. Retention ratio equals 1 – 0.40, or 0.60. Return on equity equals (10.0%)(2.0)(1.5) = 30.0%. Dividend growth rate equals (0.60)(30.0%) = 18.0%. My analysis: 1. Let’s say debt is 1.5, therefore equity must be 1.0 and total assets 2.5. 2. If total assets are 2.5, then sales are 5.0. 3. If sales are 5.0, then profit margin is 0.5 4. ROE = profit margin/equity, or 0.5/1.0 = 50%
If debt is 1.5, why is equity 1.0?
Dupont formula… (Net Profit Margin)(Asset Turnover)(Financial Leverage) = ROE
Roe equals profit margin times totals asset turnover times fin levg. Why would the profit margin differ from what’s given. Your calx are wrong, specifically with what fin levg is.
malnoll and NYCAnalyst86 have pointed the flaw correctly. Financial Leverage in ROE equation is Assets/Equity and NOT Debt/Equity. So, if Debt is 1.5 as you have taken, Equity would be 3 and Assets would be 4.5 and Sales would be 9 and NI would be 0.9 and ROE would be 0.9/3 = 30% Good analysis though. But, for exam, using simple dupont formula (as hasan has pointed) would be less time consuming and error free.
Thanks all, and Rus in particular. I was working through a series of Schweser questions today without realizing that the Dupont formula was embedded in the question. My error was assuming that financial leverage is debt/equity instead of debt/assets. Now I know and will remember for the exam. Robert .rus1bus Wrote: ------------------------------------------------------- > malnoll and NYCAnalyst86 have pointed the flaw > correctly. > > Financial Leverage in ROE equation is > Assets/Equity and NOT Debt/Equity. So, if Debt is > 1.5 as you have taken, Equity would be 3 and > Assets would be 4.5 and Sales would be 9 and NI > would be 0.9 and ROE would be 0.9/3 = 30% > > Good analysis though. But, for exam, using simple > dupont formula (as hasan has pointed) would be > less time consuming and error free.