FA Module 7 DuPont analysis practice exam questions
covering interest coverage ratio, earnings before interest and taxes, financial leverage, tax burden, interest burden, interest coverage ratio, net profit margin, return on assets, asset turnover ratio, return on equity, return on assets, financial leverage
(The attached PDF file has better formatting.)
A firm has
● an effective tax rate of 10%
● an interest coverage ratio of 6.2
● an EBIT (earnings before interest and taxes) margin of 42%
● total asset turnover of 0.43
● financial leverage of 1.9
Question 7.1: Tax burden
What is the firm’s tax burden?
Answer 7.1: 1 – 10% = 90%
(tax burden = net income / pre-tax income =
pre-tax income × (1 – tax rate) / pre-tax income =(1 – tax rate)
➾ tax burden = complement of tax rate)
Question 7.2: Interest burden
What is the firm’s interest burden?
Answer 7.2: 1 – 1 / 6.2 = 83.87%
EBT = earnings before taxes, or pre-tax income
EBIT = earnings before interest and taxes, or pre-tax income ➾ EBT = EBIT – interest expense
interest coverage ratio = EBIT / interest expense
interest burden = EBT / EBIT = (EBIT – interest expense) / EBIT =
1 – interest expense / EBIT
1 – 1 / interest coverage ratio
Question 7.3: Net profit margin
What is the firm’s net income margin (net profit margin)?
Answer 7.3: 42% × 90% × 83.87% = 31.70%
net income margin = net income / net revenue
EBIT margin = EBIT / net revenue
net income = EBIT × the interest burden × the tax burden
➾ net income margin = the EBIT margin × the interest burden × the tax burden
Question 7.4: Return on assets
What is the firm’s return on assets?
Answer 7.4: 31.70% × 0.43 = 13.63%
return on assets = net income / average assets
asset turnover ratio = average assets / net revenue
➾ return on assets = (net income / net revenue ) / (average assets / net income)
➾ return on assets = net income margin × asset turnover ratio
Question 7.5: Return on equity
What is the firm’s return on equity?
Answer 7.5: 13.63% × 1.9 = 25.90%
return on equity = net income / average equity
return on assets = net income / average assets
financial leverage = average assets / average equity
➾ return on equity = return on assets × financial leverage
(Note: the textbook formula also shows financial leverage as total assets / total equity meaning total average assets / total average equity .)
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