The following is a decomposition of the Return on Equity (ROE) for Company A and Company B:
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Question:
The following is a decomposition of the Return on Equity (ROE) for Company A and Company B:
Company A | Company B | |||
2020 | 2019 | 2020 | 2019 | |
ROE | 26.46% | 18.90% | 26.33% | 18.90% |
Tax burden | 0.70 | 0.75 | 0.75 | 0.75 |
Interest burden | 0.90 | 0.90 | 0.90 | 0.90 |
EBIT margin | 7.00% | 10.00% | 13.00% | 10.00% |
Asset turnover | 1.5 | 1.4 | 1.5 | 1.4 |
Leverage | 4 | 2 | 2 | 2 |
Required:
a. As a financial analyst what is your conclusion about the various components of the ROE for company A and Company B?
b. Explain how a company can make an effective use of leverage.
c. What does a high and low P/E ratio mean? Support your answer with numerical examples.
d. Discuss Altman’s (1968) model that can be used to quantify the likelihood that a company will default on its debt and/or declare bankruptcy.
Expert Answer:
a Return On Equity ROE NIEBT x EBTEBIT x EBITSales x SalesTotal Assets x Total AssetsEquity Tax Burden x Interest Burden x EBIT Margin x Assets Turnov... View the full answer
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