101 Concepts for the Level I Exam

Concept 50: DuPont Analysis

DuPont analysis decomposes a firm’s ROE to better analyze a firm’s performance.

Start with ROE

$ROE=\ \left({{net\ income}\over {equity}}\right)$

Traditional DuPont equation is:

$ROE=\ \left({{net\ income}\over {sales}}\right)\left({{sales}\over {assets}}\right)\left({{assets}\over {equity}}\right)$

$ROE=\ \left(net\ profit\ margin\right)\left(asset\ turnover\right)\left(leverage\ ratio\right)$

Extended DuPont equation is:

$ROE=\ \left({{net\ income}\over {EBT}}\right)\left({{EBT}\over {EBIT}}\right)\left({{EBIT}\over {revenue}}\right)\left({{revenue}\over {total\ assets}}\right)\left({{total\ assets}\over {total\ equity}}\right)$

$ROE=\ \left(tax\ burden\right)\left(interest\ burden\right)\left(EBIT\ margin\right)\left(asset\ turnover\right)\left(financial\ leverage\right)$

An analyst has gathered the following information about a company:

Operating profit margin = 12%
Average tax rate = 30%
Asset turnover ratio = 2 times
Financial leverage multiplier = 1.5 times
Interest burden = 0.6 times

Calculate the company’s ROE.

Solution:

$ROE={{Net\ income}\over {EBT}}\times {{EBT}\over {EBIT}}\times {{EBIT}\over {Revenue}}\times {{Revenue}\over {average\ assets}}\times {{Average\ assets}\over {Equity}}$