   Chapter 4, Problem 11P Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977

Solutions

Chapter
Section Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977
Textbook Problem

RATIO CALCULATIONS Assume the following relationships for the Brauer Corp.: Sales/Total assets 1.5x Return on assets (ROA) 3.0% Return on equity (ROE) 5.0% Calculate Brauer’s profit margin and debt-to-capital ratio assuming the firm uses only debt and common equity, so total assets equal total invested capital.

Summary Introduction

To determine: Profit margin and debt to capital ratio.

DuPont Analysis: Under DuPont analysis, return on equity can be calculated as a product of profit margin, total assets turnover and equity multiplier.

Debt to Capital Ratio: It represents the proportion of debt capital in firm’s total capital. Debt to capital ratio is determined by dividing total debt to total capital.

Explanation

Solution:

Given,

Return on Assets is 3%.

Return on equity is 5%.

Total asset turnover ratio is 1.5×.

Formula to calculate profit margin,

ProfitMargin=Return on AssetsTotal Assets TurnoverRatio

Substitute 3% for return on assets and 1.5× for total asset turnover ratio.

ProfitMargin=3%1.5×=0.02or2%

Here, profit margin is 2%.

Calculate debt to capital ratio through return on equity

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