lecture 11 - 59 Business Finance Lecture 11 Review of the...

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Unformatted text preview: 59 Business Finance Lecture 11 Review of the Previous Lecture ¡ Ratio Analysis ¡ Short-term solvency, or liquidity, ratios ¡ Current ratio ¡ Acid Test (Quick) ratio ¡ Cash ratio ¡ Long-term solvency, or financial leverage, ratios ¡ Total Debt ratio ¡ Interest Coverage ratio ¡ Cash Coverage Ratio ¡ Asset management, or turnover, ratios ¡ Inventory Turnover & Days’ Sale in Inventory ¡ Receivables Turnover & Average Collection Period ¡ Payables Turnover ¡ Total Assets Turnover & Capital Intensity Ratio Review of the Previous Lecture ¡ Ratio Analysis ¡ Profitability ratios ¡ Profit Margin ¡ Return on Assets ¡ Return on Equity ¡ Market value ratios ¡ Price-Earnings Ratio ¡ Market-to-Book Ratio ¡ Du Pont Identity Topics under Discussion ¡ The Du Pont Identity (cont.) ¡ Income Distribution ¡ Dividend Payout Ratio ¡ Retention Ratio ¡ Internal and Sustainable Growth ¡ Determinants of Growth ¡ Using Financial Statement Information ¡ Internal Uses ¡ External Uses ¡ Benchmarking 60 The Du Pont Identity ¡ The difference between the two profitability measures, ROA and ROE, is the use of debt financing , or financial leverage. ¡ The relationship between these measure can be illustrated by decomposing ROE into its component parts. The Du Pont Identity ¡ Recall, Net Income ROE = -------------------- Total Equity ¡ Multiplying it by Assets / Assets (without changing anything) Net Income Net Income Assets ROE = -------------------- = ---------------- x ----------- Total Equity Total Equity Assets Net Income Assets = ---------------- x ---------------- Assets Total Equity The Du Pont Identity Net Income Assets ROE = ---------------- x ---------------- Assets Total Equity ¡ So, we have expressed ROE as a product of two other ratios – ROA and the equity multiplier ROE = ROA x Equity multiplier = ROA x (1 + Debt-Equity ratio) The Du Pont Identity ¡ Looking back at A2Z: ¡ Debt-Equity Ratio = 0.39 ¡ ROA = 10.12% ¡ while ROE calculated previously = 14% ¡ Now, using the decomposition method: ROE = 10.12% x 1.39 = 14% The Du Pont Identity ¡ We can further decompose ROE by multiplying the top and bottom by total sale: Sales Net Income Assets ROE = -------- x ---------------- x ---------------- Sales Assets Total Equity 61 ¡ Rearranging a bit, Net Income Sales Assets ROE = --------------- x ----------- x ----------------...
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This note was uploaded on 08/04/2011 for the course ACCT 501 taught by Professor Na during the Spring '11 term at Virtual University of Pakistan.

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lecture 11 - 59 Business Finance Lecture 11 Review of the...

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