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16 March, 11:27

7. DuPont Identity. X Corp. has net income of $20 million, Sales of $100 million, asset turnover of. 6, and debt-equity ratio of 40%. a. What is its return on equity? b. If X increases its debt-equity ratio to 60%, what happens to its return on equity?

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  1. 16 March, 14:00
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    Net Income = 20m

    Sales = 100m

    Debt-equity ration = 40%

    Asset turnover = 0.60

    A)

    Profit Margin = Net Income / Sales = $20 million / $100 million = 20%

    Equity Multiplier = 1 + Debt-Equity Ratio = 1 + 0.40 = 1.40

    Return on Equity = Profit Margin * Asset Turnover * Equity Multiplier = 20% * 0.60 * 1.40 = 16.80%

    B)

    Debt-equity ratio = 60%

    Equity Multiplier = 1 + Debt-Equity Ratio = 1 + 0.60 = 1.60

    Return on Equity = Profit Margin * Asset Turnover * Equity Multiplier = 20% * 0.60 * 1.60 = 19.20%

    As calculations provide, if debt-equity ratio increases to 60%, Return on equity will increase by 2.40% (19.20% - 16.80%)
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