QUESTION 6
Meryl Corporation's ordinary share is currently selling at R100 per share, which represents a P/E ratio of 10.
If the firm has 100 ordinary shares outstanding, a return on equity of 20 percent, and a debt ratio of 60
percent, what is its return on total assets (ROA)?
1. 8,0%
2. 10,0%
3. 12,0%
4. 16,7%
Suggested Solution:
We will calculate the ROA using the modified (expanded) Du pont formula.
The modified Dupont formula is :
ROE (expanded)= ROA x FLM*(Equity multiplier=EM)
Net Profit
X
Sales
Sales
X
Total Assets
*Total Assets
*Total shareholders’ interest
If we cancel the sales on the above equation, we then have:
ROE =
i.e ROE =
Step 1:
Net Profit/Total Assets
X
Total Assets/ Total shareholders’ interest
[ROA
X
Financial leverage multiplier
Calculate the total asset by using the EM component (which indicates the efficiency
of using outside funds/debt)
Therefore
 Debt ratio= 1 – (Shareholders’ interest / total asset)
 60%= 1- ((R100 share price x 100 shares outstanding)/Unknown total
assets(U))
 60%=1 – (100 000/U)
 U=100 000/.4
 U=250 000
Step 2:
Solve for ROA using modified Du pont formula
ROE = ROA X Financial leverage multiplier
ROE / EM=ROA
20% /Total Assets/ Total shareholders’ interest=ROA
20% /(250 000/100000)=ROA
8%=ROA