Corporate Finance

122
Corporate Finance

Injecting debt will increase the actual return on equity as long as ROA is greater than the after-tax cost of
debt by an amount:

D/E[ROA – i(1 – T)]

This equation links ROE, ROA, D/E, tax rate and interest on debt:

The key ratios for the companies in the automotive segment are shown in Exhibit 5.3.

Exhibit 5.3 Key ratios for automotive companies (in 1996)

Turnover
Company ratio PM* ROI ROE

Ashok Leyland 1.06 0.1 137 0.1208 0.1285
Bajaj Auto 1.68 0.2228 0.3750 0.4225
Eicher Motors 3.19 0.0826 0.2637 0.3299
Escorts Limited 1.13 0.1330 0.1508 0.1760
Hero Honda 4.21 0.0756 0.3181 0.4360
Hindustan Motors 2.26 0.0825 0.1861 0.2072
Kinetic Engg. 2.11 0.1002 0.2113 0.2696
M&M 2.08 0.1209 0.2511 0.3005
TELCO 2.09 0.1216 0.2544 0.3147
TVS Suzuki 5.29 0.1061 0.5612 0.7269

• Profit margin.

Performing DuPont Analysis is not that simple. How should ROA be measured? That is, what variables
should be used in the numerator and denominator? EBIT, EBIAT, PBT, PAT are all candidates for the numerator.
Likewise total assets and net assets (net of current liabilities) are candidates for the denominator. Further,
the ratio itself has been referred to by a number of different names—return on assets, return on capital
employed, return on investment, and so on. The most consistent definition of return on assets is:

ROA =

Net assets

EBIT

where, Net assets = Fixed assets + Net working capital (excluding short-term debt).
The financial data of a hypothetical company is given in Exhibit 5.4. The rates of return on assets and
equity have been tabulated thus:

Return on assets =

Assets

Sales

1(– Tax rate)

Sales

Pre-tax profit

× ×

1997 1996 1995 1994 1993 1992 1991

ROA 6.49 7.02 7.16 6.85 5.30 4.72 6.32
ROE 16.4 17.3 17.1 16.8 12.8 11.5 14.8