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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:

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

Tax burden = 1 – tax rate = 1 – 0.3 = 0.7

ROE = 0.7 x 0.6 x 0.12 x 2 x 1.5 = 0.1512 = 15%