Nancy's Cookies maintains a profit margin of 4% and a sales to assets ratio of 3.
A. What is its return on assets?
B. If its debt-equity ratio is 1.0, its interst payments and taxes are
each $10.000 and EBIT is $40,000, what is the return on equity?

Hi!!

A. What is its return on assets?

ROA = Net Income/Total Assets =
    = Net Income/Total Assets * Sales/Sales =
    = Net Income/Sales * Sales/Total Assets =
    = Profit Margin * sales-to-asset ratio =
    = 4% * 3 =
    = 12%

The ROA is 12% .


B. If its debt-equity ratio is 1.0, its interst payments and taxes are
each $10.000 and EBIT is $40,000, what is the return on equity?

Assets = Equity + Debt ==> Debt = Assets - Equity ==>

==> Debt * Equity/Equity = Assets - Equity ==>

==> (Debt/Equity)*Equity + Equity = Assets ==>

==> Equity * (1 + Debt/Equity) = Assets ==>

==> Equity = Assets/(1 + Debt/Equity)

On thew other hand we got ROA, and also know that ROA is:
ROA = Net Income/Total Assets 

Then:
Assets = Net Income / ROA =
       = (EBIT - I - T) / ROA

Joining both results we get:
Equity = (EBIT - I - T) / [ROA * (1 + Debt/Equity)] =
       = (40000 - 10000 - 10000) / (0.12 * 2) =
       = 20000 / 0.24 =
       = 83333.333


ROE = Net Income/Equity =
    = (EBIT - I - T)/Equity =
    = 20000 / 83333.33 =
    = 0.24 


The ROE is 24% .


Hope that this helps you. Feel free to request for a clarification if you need it.

Regards.
livioflores-ga

---

Request for Answer Clarification by lily3_98-ga on 05 Oct 2005 13:21 PDT

Hi,
Could you please give me an excel spreadsheet for this.
Thanks

---

Clarification of Answer by livioflores-ga on 05 Oct 2005 16:48 PDT

Hi!!

Just do the following:
Open a new blank spreadsheet and type in each cell:
A1: Profit Margin
A2: Sales to Assets ratio
A3: ROA
A4: Debt-Equity ratio
A5: Interest payments
A6: Taxes
A7: EBIT
A8: Equity
A9: ROE
B1: 0.04
B2: 3
B3: =B1*B2
B4: 1.0
B5: 10000
B6: 10000
B7: 40000
B8: =(B7-B5-B6)/(B3*(1+B4))
B9: =(B7-B5-B6)/B8

Format it as you like, you can also add text if you find it necessary.

Hope this helps you.

Regards
livioflores-ga

Very fast, thanks!