DuPont equation

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

Which of the following equations best represents the Dupont equation?

ROE = Net profit margin * Total asset turnover * Equity multiplier

ROA = Net profit margin * Total asset turnover

ROD = Net profit margin * Total asset turnover * Debt multiplier

ROE = Net profit margin * Total asset turnover * Debt multiplier

Most investors and analysts in the financial community closely observe a companys ROE. 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 asset turnover ratio.

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

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