Question

Correctly answer each part of question 7

7. DuPont equation Corporate decision makers and analysts often use a particular technique, called a DuPont analysis, to better understand the factors that drivea company's financial performance, as reflected by its return on equity (ROE). By using the DuPont equation, which disaggregates the ROE into three components, analysts can see why a company's ROE may have changed for the better or worse, and identify particular company strengths and weaknesses. The DuPont Equation A DuPont analysis is conducted using the DuPont equation, which helps to identify and analyze three important factors that drive a company's ROE. According to the equation, which of the following factors directly affect a company's ROE? Check all that apply. Net Income/Sales Total Assets/Total Common Equity Price per Share/ Earnings per Share

Answer 1

7.

DuPont model splits ROE in to three parts as:

ROE = Net profit/Sales X Sales/Assets X Assets/Equity

The three main factors that affect ROE are Profit margin, Asset turnover and Leverages ratio.

Profit margin = Net profit/Sales

Asset turnover = Sales/Assets

Leverages ratio = Assets/Equity

Hence first two options are correct answer.

I.e. Net Income/Sales and Total assets/Total Common equity directly affect a company’s ROE.
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The profit margin and Total asset turnover between the three companies A, B and C are nearly equal. But the equity multiplier of company C is greater than other two companies which affected its ROE to be the highest.

Equity multiplier indicates the level of debt financing used to acquire assets and maintain operations.

Higher equity multiplier shows that company C is highly levered and most of its assets are funded by debt than by equity.

Hence option 2^nd “The main driver of company C’s superior ROE, as compared to that of A’s and company B’s ROE, is its greater use of debt financing.” is correct answer.