CFA Practice Question

There are 534 practice questions for this study session.

CFA Practice Question

The following information (U.S. $ millions) for two companies operating in the same industry during the same time period is available:

Company A. Net sales: 120. Total assets: 70. Total liabilities: 25.
Company B. Net sales: 300. Total assets: 140. Total liabilities: 40.

If both companies achieve a return on equity of 15% for the period, which of the following statements is most likely correct? Compared to Company B, Company A has a ______.
A. higher total asset turnover
B. lower financial leverage multiplier
C. higher net profit margin
Explanation: The DuPont system can be used to break down the ROE into three components: ROE = profit margin x total asset turnover x financial leverage multiplier.

For A and B:
Total asset turnover (sales/total assets): 120/70 = 1.71. 300/140 = 2.14. Company A has a lower total asset turnover, not a higher one.
Equity (total assets - total liabilities): 70-25=45. 140-40=100.
Financial leverage multiplier (assets/equity): 70/45=1.56. 140/100=1.40. Company A has a higher financial leverage multiplier, not a lower one.
Company A's Net Profit Margin from ROE: 15% = (net profit margin) x 1.71 x 1.56. Net profit margin of A = 5.6%
Company B's Net Profit Margin from ROE: 15% = (net profit margin) x 2.14 x 1.40. Net profit margin of B = 5.0%
Company A has a higher net profit margin than Company B.

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