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Fundamentals of Financial Manageme...

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

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

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

Suppose you were comparing a discount merchandiser with a high-end merchandiser. Suppose further that both companies had identical ROEs. If you applied the DuPont equation to both firms, would you expect the three components to be the same? for each company? If not, explain what balance sheet and income statement items might lead to the component differences.

Summary Introduction

To determine: Whether equal return on equity of two companies means equal other components included in it and the items of financial statement that leads to the component differences.

Introduction:

Return on Equity (ROE):

Return on equity represents the amount of return earned by equity shareholders. It can be calculated by dividing earnings available for equity shareholders to total equity capital.

DuPont Analysis:

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

Explanation
  • Discount Merchandisers provide products at a discount, so they have a low profit margin and high total assets turnover ratio.
  • High end Merchandiser involves in marketing and selling products through innovative techniques. So, they can have a high profit margin while total assets turnover ratio is less.
  • Formula to calculate return on equity,

Return on Equity=NetIncomeCommon

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