Question

If net profit margin is 5.0 percent, rate of asset turnover is 4.0x, and financial leverage is 2.0x, then return on net worth is:

1) 8.0 percent
2) 10.0 percent
3) 20.0 percent
4) 40.0 percent
5) 80.0 percent

Answer 1

The return on net worth, also known as return on equity (ROE), is calculated using the Dupont formula. In this case, ROE is 40 percent, obtained by multiplying a net profit margin of 5.0 percent, an asset turnover rate of 4.0x, and financial leverage of 2.0x.

Step-by-step explanation:

To determine the return on net worth, also known as return on equity (ROE), we use the Dupont formula which combines the net profit margin, rate of asset turnover, and financial leverage into a single measure of profitability. Given:

• Net profit margin: 5.0 percent
• Rate of asset turnover: 4.0x
• Financial leverage: 2.0x

The return on net worth is calculated by multiplying these three factors:

Return on Equity (ROE) = Net Profit Margin x Asset Turnover x Financial Leverage

ROE = 0.05 (5.0%) x 4.0 x 2.0 = 0.40 or 40 percent. Therefore, the correct answer is 4) 40.0 percent.