Question

Using the Du Pont method, evaluate the effects of the following relationships for the Butters Corporation. a. Butters Corporation has a profit margin of 8 percent and its return on assets (investment) is 17.75 percent. What is its assets turnover? (Round your answer to 2 decimal places.) b. If the Butters Corporation has a debt-to-total-assets ratio of 30.00 percent, what would the firm’s return on equity be? (Input your answer as a percent rounded to 2 decimal places.) c. What would happen to return on equity if the debt-to-total-assets ratio decreased to 25.00 percent? (Input your answer as a percent rounded to 2 decimal places.)

Answer 1

The asset turnover for Butters Corporation is 2.22, the return on equity (ROE) with a debt-to-total-assets ratio of 30.00 percent is 25.36%, and if the ratio decreases to 25.00 percent, the ROE would be 23.67%.

Step-by-step explanation:

We are asked to examine the relationship between profitability ratios using the Du Pont method for the Butters Corporation. The Du Pont formula is a strategic way to look at two major determinants of return on equity (ROE): operational efficiency as measured by profit margin and asset use efficiency as indicated by asset turnover.

a. Calculating Asset Turnover:

The asset turnover can be calculated using the return on assets (ROA) formula, which is ROA = Profit Margin × Asset Turnover. Given that Butters Corporation has a profit margin of 8 percent and a ROA of 17.75 percent, we can derive the asset turnover by rearranging the formula: Asset Turnover = ROA / Profit Margin = 17.75% / 8% = 2.21875, which rounded to two decimal places is 2.22.

b. Calculating Return on Equity (ROE):

The return on equity can be calculated with the formula ROE = ROA / (1 - Debt-to-Total-Assets Ratio). Substituting the given values, ROE = 17.75% / (1 - 30.00%) = 17.75% / 0.70 = 25.36%, rounded to two decimal places is 25.36%.

c. Effect of a Decreased Debt-to-Total-Assets Ratio on ROE:

If the debt-to-total-assets ratio decreases to 25.00 percent, the ROE would then be recalculated as ROE = 17.75% / (1 - 25.00%) = 17.75% / 0.75 = 23.67%, so the new ROE would be 23.67% rounded to two decimal places.

Answer 2

Part a = 2.22 %

Part b = 25.36%

Part c = 23.67%

Step-by-step explanation:

The Du Pont method is that method which defines the return on equity into three parts that includes gross profit margin, asset turnover, and financial leverage.

The profit margin and asset turnover show the relation with sales revenue whereas the financial leverage show a ratio of debt and shareholder equity.

a. Asset turnover : In duo Pont method,the asset turnover formula :

= Return on Assets ÷ Profit margin

= 17.75% ÷ 8%

= 2.22 %

b. The Return on equity is equal to

= Return on assets ÷ (1 - debt to total assets ratio)

= 17.75% ÷ (1-0.30)

= 25.36%

c. Applying same formula which is used in part b

Return on equity = Return on assets ÷ (1 - debt to total assets ratio)

= 17.75% ÷ (1 - 0.25)

= 17.75% ÷ 0.75

= 23.67%

Hence, Part a = 2.22 %

Part b = 25.36%

Part c = 23.67%