Most investors and analysts in the financial community pay particular attention

Question

Most investors and analysts in the financial community pay particular attention to a company's ROE. The ROE can be calculated simply by dividing a firm's net income by the firm's shareholder's equity, and it can be subdivided into the key factors that drive the ROE. Investors and analysts focus on these drivers to develop a clearer picture of what is happening within a company. An analyst gathered the following data and calculated the various terms of the DuPont equation for three companies: Company A Company B Company C ROE Profit Margin x Total Assets Turnover x Equity Multiplier 12.0% 15.5% 21.5% 57.3% 58.2% 58.0% 9.8 10.2 10.3 2.14 2.61 3.60 Referring to these data, which of the following conclusions will be true about the companies' ROEs? O The main driver of company A's inferior ROE, as compared to that of company B's and company C's ROE, is its use of higher debt financing 0 The main driver of company C's superior ROE, as compared to that of company A's and company B's ROE, is its greater use of debt financing. O The main driver of company C's superior ROE, as compared to that of company A's and company B's ROE, is its efficient use of assets.

Explanation / Answer

The true conclusion about ROE's of three companies is:

The main driver of Company C's superior ROE as compared to that of Comapny A's and Company B's ROE, is greater use of debt financing.

If we compare, the Profit Margin of three companies, the difference is less than 1%, and the assets turnover is also having difference less than 1 for all the three companies. However the differnce in Equity Multiplier is more than 1 for C from Company A and B. Since Total Asset turnover and Equity Muliplier both are highest for Company C, it has highest ROE.

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