Dupont Analysis

4–13. (DuPont analysis) Garwryk, Inc., which is financed with debt and equity, presently has a debt ratio of 80%. What is the firm’s equity multiplier? How is the equity multiplier related to the firm’s use of debt financing (i.e., if the firm increased its use of debt financing would this increase or decrease its equity multiplier)? Explain.

A

Presented: Debt Ratio = 80%

=.8

Equity Multiplier = __1___

1- Debt Ratio Equation is (4-14a) on p. 93

= __1_____

1-.8

= 5

B

Debt ratio = 1 - (1/equity multiplier)

(80%) (equity multiplier) = 1 equity multiplier - 1

80% equity multiplier = 1 equity multiplier - 1

100% equity multiplier - 1 = 80% equity multiplier

100% equity multiplier -80% equity multiplier = 1

20% equity multiplier = 1

Equity multiplier = 1/20%

Equity multiplier = 5

Initially let’s review the term “Debt ratio.” This ratio portrays what share of debt/liability an organization has relating to its assets. The debt ratio assessment paints a picture of the organization’s leverage as well as possible risks, which may be encountered as relating to its debt-load (Titman, Keown, & Martin, 2011). The calculation of an organization’s debt ratio would look like this:

Debt Ratio = Total Debt

Total Assets Equation is (4-6) on p. 85

The equity multiplier is generally used toward measuring the degree that organizations finance their assets with debts. Equity multiplier is a vital factor within assessing the financial strength of an organization, such as the effect of their debt affecting the rate of Return on Equity (ROE). A higher equity multiplier is an indicator for higher financial leverage, which denotes an organization is heavily reliant upon debt toward financing its assets. As the debt ratio...