Steve's ski shop has a net income of $389,000 with total sales of $2.5 million. Currently, the shop has debt of $500,000, equity of $800,000; receivables are 1.5 percent of sale, and Average total assets of $2,000,000. What is the Return on Equity? (Use the DuPont Identity)
To calculate the Return on Equity (ROE) using the DuPont Identity, we need to multiply three components together: the Net Profit Margin, the Total Asset Turnover, and the Equity Multiplier.
1. Net Profit Margin (NPM):
Net Profit Margin is calculated by dividing the Net Income by the Total Sales.
NPM = Net Income / Total Sales
In this case, the Net Income is $389,000 and the Total Sales are $2.5 million, so:
NPM = $389,000 / $2,500,000 = 0.1556 (or 15.56%)
2. Total Asset Turnover (TAT):
Total Asset Turnover is calculated by dividing the Total Sales by the Average Total Assets.
TAT = Total Sales / Average Total Assets
In this case, the Total Sales are $2.5 million and the Average Total Assets are $2,000,000, so:
TAT = $2,500,000 / $2,000,000 = 1.25
3. Equity Multiplier (EM):
Equity Multiplier is calculated by dividing the Total Assets by the Total Equity.
EM = Total Assets / Total Equity
In this case, the Total Assets are $2,000,000 and the Total Equity is $800,000, so:
EM = $2,000,000 / $800,000 = 2.5
Now, we can calculate the Return on Equity (ROE) by multiplying the three components together:
ROE = NPM * TAT * EM
ROE = 0.1556 * 1.25 * 2.5
ROE = 0.1945 (or 19.45%)
Therefore, the Return on Equity (ROE) for Steve's ski shop is 19.45%.