 # Ratio Analysis - FSA Q

The following financial ratio information is available for a company: EBIT Margin 0.16 Total Asset Turnover 1.11 Interest Burden 0.90 Financial Leverage Ratio 2.70 Tax Retention Ratio (1-tax rate) 0.60 The company’s ROE is closest to: a. 11.5% b. 15.5% c. 17.3% d. 28.8% I keep getting 25.89% using the expanded Du-pont model. Where am I going wrong?

is the answer 17.3% ©?

ouch…I stopped at (NI+0.54)/E = 0.2877 Solve for NI/E from above!!!

FisherSU is right, the answer is C. I don’t get it. 0.16*0.4*0.9*1.11*2.7 Why 0.4 instead of 0.6? 0.6 is the % of EBT that you keep, 0.4 is what you pay.

I guess it would make sense to use .40 (tax burden). It is consistent with multiplying by .9 (interest burden). Factoring .40 serves to reduce EBIT just as factoring .9 serves to reduce EBT by the interest burden

Yeah, but Interest Burden = EBT/EBIT = .9, this means that you pay 10% of EBIT in interest and and keep 90%. Tax Burden = NI/EBT, in this case you would pay 40% of EBT in taxes and keep 60% as NI. Therefore NI/EBT = .6 Am I thinking about this wrong?

You don’t use tax retention rate in ROE (1-T) but the tax effect on ROE which is 1-(T/EBT).

According to CFA Book 3 Page 607: The first term on the right-hand side of this equation measures the effect of taxes on ROE. Essentially, it reflects one minus the average tax rate, or … So it should use 60% instead.

but how we get interest expense rate from interest burden??? i kept getting 25.89% by using Dupont equations.!!!

I get the same. You should use 0.6 and not 0.4 i think

Also on CFAI book 4 page 143. 1 - tax rate should be used. The correct answer is 25.89.

Hi all I think all of you are looking at this problem wrongly. As I prove below, the Interest Burden is purely a distractor, and you get the right answer choice D, down to the decimal place. EBIT Margin 0.16 Total Asset Turnover 1.11 Interest Burden 0.90 Financial Leverage Ratio 2.70 Tax Retention Ratio (1-tax rate) 0.60 The company’s ROE is closest to: a. 11.5% b. 15.5% c. 17.3% d. 28.8% ROE = NI / CE = NI / NS * NS / TA * TA / CE = EBIT (1-T) / NS * NS / TA * TA / CE = EBIT / NS * NS / TA * TA / CE * (1-T) = EbIT Margin * TAT * Financial Leverage * Tax Retention = .16 * 1.11 * 2.7 * .6 = .2877 --> 28.8% CP

But as the poster mentioned above the answer is C…??? anything wrong wif this question? cpk123 Wrote: ------------------------------------------------------- > Hi all > > I think all of you are looking at this problem > wrongly. As I prove below, the Interest Burden is > purely a distractor, and you get the right answer > choice D, down to the decimal place. > > EBIT Margin 0.16 > Total Asset Turnover 1.11 > Interest Burden 0.90 > Financial Leverage Ratio 2.70 > Tax Retention Ratio (1-tax rate) 0.60 > > The company’s ROE is closest to: > > a. 11.5% > b. 15.5% > c. 17.3% > d. 28.8% > > ROE = NI / CE > = NI / NS * NS / TA * TA / CE > = EBIT (1-T) / NS * NS / TA * TA / CE > = EBIT / NS * NS / TA * TA / CE * (1-T) > = EbIT Margin * TAT * Financial Leverage > * Tax Retention > = .16 * 1.11 * 2.7 * .6 = .2877 --> > 28.8% > > CP

cpk123 Wrote: ------------------------------------------------------- > Hi all > > I think all of you are looking at this problem > wrongly. As I prove below, the Interest Burden is > purely a distractor, and you get the right answer > choice D, down to the decimal place. > > EBIT Margin 0.16 > Total Asset Turnover 1.11 > Interest Burden 0.90 > Financial Leverage Ratio 2.70 > Tax Retention Ratio (1-tax rate) 0.60 > > The company’s ROE is closest to: > > a. 11.5% > b. 15.5% > c. 17.3% > d. 28.8% > > ROE = NI / CE > = NI / NS * NS / TA * TA / CE > = EBIT (1-T) / NS * NS / TA * TA / CE > = EBIT / NS * NS / TA * TA / CE * (1-T) > = EbIT Margin * TAT * Financial Leverage > * Tax Retention > = .16 * 1.11 * 2.7 * .6 = .2877 --> > 28.8% > > CP you forget the interest/assets???

If tax retention = 1- tax rate, then the tax rate is the tax burden. So it should be .40 right? According to the quick notes it’s tax burden * int burden * EBIT margin = NI/EBT

amberpower Wrote: ------------------------------------------------------- > If tax retention = 1- tax rate, then the tax rate > is the tax burden. So it should be .40 right? > According to the quick notes it’s tax burden * int > burden * EBIT margin = NI/EBT Yes, The solution is : (0.16x0.4)x0.90 x 1.11 x 2.70

So CP is wrong with his calculation??? strangedays Wrote: ------------------------------------------------------- > amberpower Wrote: > -------------------------------------------------- > ----- > > If tax retention = 1- tax rate, then the tax > rate > > is the tax burden. So it should be .40 right? > > According to the quick notes it’s tax burden * > int > > burden * EBIT margin = NI/EBT > > > Yes, The solution is : > (0.16x0.4)x0.90 x 1.11 x 2.70

What is tax burden? I think it is NI/EBT Now if EBT is 100 and tax rate is 40%, NI will be 60. So tax burden is 60/100. So, shouldn’t we using 0.6 (1-t) itself?