For a firm that reports equity income as non-operating income, removing equity income form the financial statements would most likely result in an increase in the tax burden term in the extended dupont decomposition of ROE. Tax burden = NI/EBT The decrease in NI form removing the Equity income will decrease the term (an apparently greater reduction in ROE due to taxes). After the explanation above, I still don’t get it. Can anyone plz clarify?
Just what I thought… Damn!
that is an explanation of what? was it a question? i dont get what you’re asking
Hi Ryan, What I wrote above is a correction of a question from schweser. But I still don’t get it. Why would it result in an increase of tax burden?
charly, while I have no idea what you’re referencing, I think I can guess the source of the confusion. Obviously if NI gets smaller so will NI/EBT (negatively affecting the ROE from an extended DuPont). NI/EBT is the ratio of post-tax income to pre-tax income - it is somewhat oddly referred to as the tax burden. This is counter-intuitive, since the “burden” in ordinary language would be the ratio of tax to EBT (or (NI-EBT)/EBT). Just guessing, but could this be the problem - that a smaller “tax burden” actually means more tax to pay proportionally? In the DuPont equation, if you’re salvaging less return, due to a smaller “tax burden”(!), your ROE will decline accordingly.
EBT(1-T) = NI NI/EBT grows smaller so 1-T grows smaller which can only happen if T grew bigger!!