Equity multiplier is a financial leverage ratio which is calculated by dividing total assets by the shareholders equity. It tells about assets in dollar per dollar of equity. The higher the ratio the lower the financial leverage and the lower the ratio the higher the financial leverage.
|Equity Multiplier =||Total Assets|
Equity multiplier is an important input in the DuPont return on equity analysis. DuPont return on equity analysis breaks up ROE into net profit margin, asset turnover and financial leverage (represented by equity multiplier as shown below:
|ROE Under DuPont Analysis =||Net Income||×||Sales||×||Total Assets||=||Net Income|
|Sales||Total Assets||Total Equity||Total Equity|
Higher equity multiplier leads to a higher return on equity.
Example 1: Company EP has total assets of $100 billion, beginning equity of $40 billion, net income for the year of $10 billion and dividends paid during the year of $4 billion.
We calculate the equity multiplier as total assets divided by total equity.
Total assets are $100 billion
Total equity = beginning equity + net income − dividends = $40 b plus $10 b minus $4 b = $46 billion
Equity multiplier is hence $100 billion divided by $46 billion and it equals 2.2
Example 2: Company DP has debt to equity ratio of 2. Find the equity multiplier
Debt/Equity = 2
Since debt = assets minus equity
(Assets − Equity)/Equity = 2
Assets − Equity = 2 Equity
Assets = 3 Equity
Assets/Equity = 3
Hence, equity multiplier is 3.
For further analysis of equity multiplier as part of DuPont analysis refer to: DuPont Analysis.
Written by Obaidullah Jan