Q:
A:
Demonstrate,
using equations from the Dupont or similar ratio model,
how and why a highmargin business such as an Auto Dealership
(AD) can have the same Return
on Equity as a lowmargin donut shop business (DS).
The key to this question is the relationship between
margins and turns in the ROE portion of ratio models
and formulas.
ROE = NI/E = Sales/E * NI/Sales
Or in other words,
ROE = Margins * Equity Turns
In the case of this example, assume AD and DS both have a ROE of 12%. From the model:
AD = .24 * .5 = .12 ("Half a turn")
DS = .01 * 12 = .12 ("12 turns")
In
other words when generating ROE:
higher margins times lower turns = lower margins times
higher turns
(Don't confuse, but relate, turns with returns).
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