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**CFA Practice Question**

You are given the following financial data: net income/sales = 4%; sales/total assets = 4.5; debt/total assets = 60%. What is the firm's return on equity?

B. 18%

C. 45%

A. 8.5%

B. 18%

C. 45%

Correct Answer: C

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**User Contributed Comments**
17

User |
Comment |
---|---|

kalps |
How is this calculated, are they saying it is Sales/total assets ???? |

gjwhite |
equity = assets - liab --> equity/assets = 1 - liab/assets = 1 - .6 = .4 --> assets/equity = 1/.4 = 2.5 = financial leverage therefore ROE = 4 x 4.5 x 2.5 = 45 |

cbb1 |
Return on Equity = Operating Profit % of 4% Multiplied By Asset Turnover (sales/total asset) of 4.5 Multiplied by Equity Multiplier (asset/equity) of 2.5 Compute the 2.5 since debt to total assets equals 60%, equity to total assets must be 40% and then take the reciprocal results in 2.5 |

richcfa2 |
don't forget this if they ask** trick |

mtcfa |
I guess this makes the previous question valid. |

ninagraham |
how did they calculate the equity multiplier as 2.5? |

jasonk |
hi nina, take a look at answer/explanation from cbb1. |

todolist |
Cool Q. |

viannie |
asset = liability + equity if debt / asset = 60% asset being 100%, then equity/total asset = 40% total asset = 1/0.4 = 2.5 thanks cbb1! |

rocyang |
indeed cool question. But, how can you determine if the final output should be in percentage? |

Gpcurve |
Assume Assets = 100 Sales = 4.5 x 100 = 450 NOI = 450 x 4% = 18 Equity = 100 x (1-60%) = 40 ROE = 18/40 = 45% |

bsm9 |
Thanks gpcurve! |

KarenMaciel |
i like this question!!! |

robertucla |
Analystnotes pisses me off when doesn't provide solution. |

ldfrench |
^Heard that, brother |

Kevdharr |
If a firm's debt/total assets ratio is 60%, then it stands to reason that their equity/total assets would be 40%. DuPont formula requires you to use the equity multiplier in which is total assets/common equity. So if you just take the inverse of equity/total assets (which is 40%), you get 2.5 (1/.4=2.5). You are already given the other two parts of the equation. So just multiply 4*4.5*2.5 and you get 45. |

ioanaN |
assets=debt+equity debt/assets+equity/assets=1 equity/assets=1-debt/assets=1-0.6=0.4 assets/equity=1/0.4=2.5 |