Chapter 3 Questions

7. If jPhone, Inc., has an equity multiplier of 1.35, total asset turnover of 1.64, and a profit margin of 7
percent, what is its ROE?

With the information given, we must use the Du Pont identity to calculate return on equity. Doing so, we
find:

ROE = (Profit margin)(Total asset turnover)(Equity multiplier)

ROE = (.07)(1.64)(1.35)
ROE = .1550, or 15.50%

8. Jimmy Cricket Removal has a profit margin of 8 percent, total asset turnover of 1.16, and ROE of
14.30 percent. What is the firm’s debt-equity ratio?

We can use the Du Pont identity and solve for the equity multiplier. With the equity multiplier we can
find the debt-equity ratio. Doing so we find:

ROE = (Profit margin)(Total asset turnover)(Equity multiplier)

.143 = (.08)(1.16)(Equity multiplier)
Equity multiplier = 1.54

Now, using the equation for the equity multiplier, we get:

Equity multiplier = 1 + Debt-equity ratio

1.54 = 1 + Debt-equity ratio
Debt-equity ratio = .54

17. Suppose that the Bethesda Mining Company has sales of $2,156,873 and net income of $109,381 for
the year ending December 31, 2010. Calculate the Du Pont Identity.

Other information obtained from the balance sheet is that total assets were $900,828. Total debt was
$527,939. And total equity was $372,879.

Using the Du Pont identity to calculate ROE, we get:

ROE = (Profit margin)(Total asset turnover)(Equity multiplier)

ROE = (Net income / Sales)(Sales / Total assets)(Total asset / Total equity)
ROE = ($109,381 / $2,156,873)($ 2,156,873/ $900,828)($900,828 / $372,879)
 PM=0.05 TAT=2.39 EM=2.42
ROE =.2892, or 28.92%

18. The Delson Company had a ROA of 9 percent, an 8 percent profit margin, and a ROE of 14 percent.
What is the company’s total asset turnover? What is the equity multiplier?

ROA = (Profit margin)(Total asset turnover)

We can solve this equation to find total asset turnover as:

.09 = .08(Total asset turnover)

Total asset turnover = 1.12 times

Now, solve the ROE equation to find the equity multiplier which is:

ROE = (ROA)(Equity multiplier)

.14 = .09(Equity multiplier)
Equity multiplier = 1.56 times

22. Kaleb’s Karate Supply had a profit margin of 10%, sales of $21 million, and total assets of $9.5
million. What was total asset turnover? If management set a goal of increasing total asset turnover to 2.75
times, what would the new sales figure need to be, assuming no increase in total assets?

Total asset turnover = Sales / Total assets

Total asset turnover = $21,000,000 / $9,500,000 = 2.21 times

If the target total asset turnover is 2.75 times, we can use the total asset turnover equation to solve
for the necessary sales level. The new sales level will be:

Total asset turnover = Sales / Total assets

2.75 = Sales / $9,500,000
Sales = $26,125,000

Challenge question: Y3K, Inc., has sales of $7,385, total assets of $3,480, and a debt-equity ratio of .25. If
its return on equity is 16 percent, what is it net income?

ROE=(Net Income/ Sales)(Sales/ Total Assets)(1+debt-equity ratio)

.16=(Net Income/$7,385)( $7,385/$3,480)(1+.25)

Net Income=$445.44