 # Net Profit Margin under Equity Method vs Consolidation Method

Probably a silly question but my head just can’t wrap around the following question from Schweser note:

A company accounts for its investment in a subsidiary using the equity method. The reported net profit margin is 14%. An analyst adjusts the financials and determines that the company’s own net profit margin is 8% while the subsidiary’s profit margin is 10%. The netprofit margin based on consolidation would most likely be:

A. less than 8%.

B. more than 14%.

C. between 8% and 14%.

The Answer is C because The equity method typically yields a higher measure of net profit margin.Consolidation is most likely to result in a net profit margin somewhere between the profit margins of the two entities.

I’m not sure if I misinterpreted the question but I assume ‘Consolidation’ refers to Acqusition method right? And under all these methods, the Net Income remains the same. However, the revenue is the smallest under the Equity method rwhich means Net Profit Margin (NI/Revenue) should be the greatest (in this case, it’s 8%).
So based on consolidation method this would only increase the Revenue and thus make the NPM smaller (less than 8%). So why it’s not A?

Any help is appreciated!

Consolidation over here implies the consolidated financials which the Holding company would prepare. And under equity method, margins are always higher because Revenue is less. The consolidated NP Margin won’t exceed 14% since it’s a given cap

Hi,
under the Equity Method you consolidate the pro rata net income of the investment but not the revenue.
Since PM = NI / Revenue the nominator increases and the denominator stays constant. As such, under the equity method margins will always increase.
Regards,
Oscar

I think your main weakness may be unrelated to understanding of the underlying concept, and more to do with simple comprehension (is English a second language?)

Question states: “A company accounts for its investment in a subsidiary using the equity method. The reported net profit margin is 14%.” Which I interpret as: Profit margin (equity method) = 14%.

You state “. However, the revenue is the smallest under the Equity method rwhich means Net Profit Margin (NI/Revenue) should be the greatest (in this case, it’s 8%).” Which I seem to interpret that you interpret profit margin is 8% under equity method.

See what I mean?