The following data have been obtained from a firm's financial statements: operating profit margin 34% interest expenses 465 depreciation expenses 123 debt-to-equity ratio 0.60 total assets 2,375 total sales 4,109 tax rate 37%
The firm's ROE equals ________.
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A. B. C. D.D
The answer to this requires you to know the extended duPont system. However, you should NOT rely on your memory for complex formulas. Rather, start from the primary quantity needed (ROE here) and use some basic definitions and common sense. This approach will ensure that you are not caught by surprise during the exam. You need to calculate net income and total equity to obtain ROE, since ROE = net income/total equity. Operating profits equal earnings before depreciation, interest and taxes (EBDIT). The operating profit margin expresses EBDIT as a fraction of total sales and indicates the level of profitability of the firm. In this case,
EBDIT = 4109*34% = 1,397. Since interest expenses are taxdeductible, EBT = 1,397 - interest expense - depreciation = 1,397 - 465 - 123 = 809. Therefore, net income after taxes = 809*(1 - 37%) = 510. Also, debt + equity = total assets and debt = 0.6*equity (given). So total assets = 2,375 = 1.6*equity, giving equity =
2,375/1.6 = 1,484. Finally, ROE = 510/1484 = 34.34%.