I noticed this equation in Scheweser notes fro ROE: ROE=(EBIT/S)(S/A)-(I/A)(1-t) Can someone please tell me where this came from. I am having a hard time deriving it from basic ROE equation. thank you NG
That formular does not seem okay to me. However, the decomposition of ROE(Dupont Analysis) is as follows: ROE=ROA*Financial Leverage ROA=Net Profit Margin*Total Asset Turnover Of which the net profit margin=(NI/EBT)*(EBT/EBIT)*(EBIT/R) Combining the five we get ROE=(NI/EBT)*(EBT/EBIT)*(EBIT/R)*(R/TA)*(TA/TE).
I have had a look at that question again and it appears what they have done is decomposing this formular further. The first component is the Operating Profit Margin, which is being adjusted by the tax retention rate, coupled with the interest burden adjustment to total assets turnover. Multiplying this by financial leverage should give us also ROE. I hope this helps.
it is all decomposing the levers that go into ROE. net net, you want to look at a companys ROE and see: 1 - are they increasing ROE from selling more at a higher profit (margin boost) 2- adding on debt 3- selling more at faster turns (efficiency in other words) put in context, Walmart vs Blue Nile. clearly, WMT sells low margin shi*, but they sell it all day and are very efficient. that drives ROA, which drives ROE blue nile, doesnt sell often, but when it does, it is boom! to the bottm line, since they sell higher priced things (plus, I would expect Blue nile to have good margin in general b/c they are selling off a web infrastructure and probably have good invetory turns/management. Web infrastructure which has high fixed costs at fist [hence, AMZN did not generate FCF until 2000, i think], but after that is built, more profits should flow to the bottom line [this is called operational leverage – and yes, it is on the exam – go to corp finance book, i think] hope that helps at the margin
boilermaker, JOE and others having trouble with the equation in Schweser… It is perfectly valid, and can be derived Simple Algebra does it: ROE=NI/CE = (EBIT-Int)*(1-T)/CE = (EBIT-Int)/CE * (1-T) = (EBIT-Int)/TA * TA/CE * (1-T) = (EBIT/TA - Int / TA) * TA/CE * (1-T) = [(EBIT/NS * NS /TA) - Int /TA] * TA/CE * (1-T) = [(Operating Profit Margin * Total Asset Turnover) - Int Coverage] * Fin. Leverage * (1-T) This equation goes on to depict the various components of ROE. How the various things tie in together… CP
Many thanks CP.