CFA Practice Question

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CFA Practice Question

The equity method
A. Results in a higher net profit margin than the proportionate consolidation method.
B. Results in a higher return on equity than the proportionate consolidation method.
C. Results in higher net income than the proportionate consolidation method.
Explanation: The equity and proportionate consolidation methods produce the same net income and equity. The difference is that the proportionate consolidation method adds in the percentage of sales and expenses of the investee company owned to the consolidated totals. As a result, the equity method results in a higher net profit margin. Since income and equity are the same, parts (b) and (d) are false. Also, since the proportion owned of the investee company assets are added into the consolidated totals (and equity is the same), financial leverage (Assets to equity) is higher for the proportionate consolidation method and (c) is false as well.

User Contributed Comments 2

User Comment
vi2009 but higher in ROA for equity over proportionate consolidation.
aravinda A is only correct....

NPM is high in Equity Method....
TAT - Remains the same between both methods
Leverage - Equity method results in lower Leverage compared to Proportionate Consolidation method.

And we know that NPM & Leverage are 2 of the 3 components of ROE according to Dupont....

NPM = NI / Sales
ROE = { (NI/Sales) * (Sales/Average Total Asset) * (Average Total Assets / Average total Equity) }

'B' is false since NPM & LEverage has opposite effects on ROE
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