CFA CFA Level 1 CFA Level 1 Question of the Week: Return on Equity

CFA Level 1 Question of the Week: Return on Equity

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    • exam_whiz
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      Mark Anderson, financial analyst, is discussing the ways to analyze a firm’s return on equity (ROE) with his colleague. While discussing the DuPont system of analysis, Mark states, “The DuPont equation is very useful in the analysis of return on equity. It breaks ROE into three key components – net profit margin, asset turnover and equity multiplier.”

       His colleague agrees and adds, “If any one of the three components – net profit margin, asset turnover or use of equity increases, ROE will increase.”

      Are the statements made by Mark and his colleague correct?

      • Mark is right, but his colleague is wrong
      • Mark is wrong, but his colleague is right
      • Both of them are right
    • hairyfairy
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      I’m not sure what you mean by ‘use of equity’… @exam_whiz‌?

    • policedog
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      Yeah I was confused by that one. Any one else knows?

    • jak5189
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      Avg. Assets / Avg. Equity; I think “use of equity increases” means the denominator of the equity multiplier ratio increases. I went that assumption but lets see.

    • policedog
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      I assumed some measure of ‘how well equity is being utilised’ and decided it wasn’t the equity multiplier.  :

    • policedog
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      @jak5189‌ haven’t seen you around the forum much BTW but awesome quiz performance 🙂

    • simply_complex2
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      i took it as meaning that the colleague thought the equity multiplier measures how much equity a company uses….not sure if i read it wrong though!

    • simply_complex2
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      even if the way i interpreted it is wrong, and the guy was just saying use of equity increases ROE (unrelated to equity multiplier) he would still be wrong since more equity would generally dilute ROE (ex: NI = 500, Equity = 1000 vs 10,000)

    • jak5189
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      @policedog just kicking butt and taking names 🙂

    • exam_whiz
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      Sorry for the unclear question!

      @jak5189 was on the right track for what we were trying to test- the impact on the equity multiplier ratio.

    • hairyfairy
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      Thanks for the clarifications @jak5189‌ and @exam_whiz‌!

    • hairyfairy
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      @jak5189‌ not much hope at overtaking you at your current performance, but one can hope.

    • jak5189
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      @hairyfairy I’ll probably hit a rut at some point 🙂

    • dhanin
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      anyone know where can download the cfa level 1 mock question for practice?

    • hairyfairy
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      @dhanin, @paulpassedtense‌ is looking for beta testers at the moment – send him a PM ASAP!

    • exam_whiz
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      @jak5189‌ What topic do you need the most work on?  I can throw a tough one on next week to give others a chance to catch up 🙂   @hairyfairy‌  

    • exam_whiz
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      The correct answer of this one is A.

      The DuPont equation is very useful in the analysis of return on equity.  It breaks ROE into three key components – net profit margin, asset turnover, and equity multiplier.  Equity multiplier is the ratio assets/equity.  It increases as the use of debt financing increases.  Thus, his colleague is wrong.

    • jak5189
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      @exam_whiz Demand and Supply Analysis: The Firm and The Firm and Market Structures are tough ones for me. Lets see what you got to whip me into shape 🙂

    • simply_complex2
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      @dhanin, if you’re looking for the practice exams the CFA institute provides, log into the CFA institute’s website, click CFA programs under “programs” on the blue bar and then click candidate resources on the left hand side. they will be listed under tools

    • shannondaily
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      Boo! I got it wrong. :neutral_face: 

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