Corporate decision makers and analysts often use a particular technique, DuPont analysis, to better understand the factors that drive company performance, as reflected in its return on common equity (ROE). By using the DuPont equation, which disaggregates its ROE into three components, analysts can see why the companys ROE may have changed for better or worse and identify company strengths and weaknesses.

The DuPont equation

DuPont analysis is conducted using the DuPont equation, which helps you analyze three important factors that drive a companys ROE. According to the equation, which of the following factors affect a companys ROE directly? Check all that apply.

Market-to-book-value ratio

Operational efficiency

Efficiency in use of total assets

Most investors and analysts in the financial community observe the ROE closely. The ROE can be calculated simply by dividing net income by the shareholders equity, and it can be subdivided into the key factors that drive the ROE. Investors and analysts focus on these drivers to develop a clearer picture of what is happening in a company. An analyst gathered the following data and calculated the various terms of the DuPont equation for three companies:

	ROE	=	Profit Margin	x	Total Assets Turnover	x	Equity Multiplier
Company A	12.0%		57.3%		9.8		2.14
Company B	15.5%		58.2%		10.2		2.61
Company C	21.5%		58.0%		10.3		3.60

Referring to these data, which of the following conclusions will be true about the companies ROEs?

The main driver of company As inferior ROE, as compared to that of company Cs ROE, is its higher total assets turnover ratio.

The main driver of company Cs superior ROE, as compared to that of company As and company Bs ROEs, is its greater use of debt financing.

The main driver of company As inferior ROE, as compared to that of company Bs and company Cs ROEs, is its use of higher debt financing.