Question

finance

5. The DuPont equation Corporate decision makers and analysts often use a particular technique, called a DuPont analysis, to better understand the factors that drive a 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 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. Price per Share / Earnings per Share Total Assets / Total Common Equity Net Income / Sales Most investors and analysts in the financial community pay particular attention to a company's ROE. The ROE can be calculated simply by dividing a firm's net income by the firm's shareholder's 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 within a company. An analyst gathered the following data and calculated the various terms of the DuPont equation for three companies: = X x Company A Company ROE 12.0% 15.5% Profit Margin 57.3% 58.29% Total Assets Turnover 9.8 10.2 Equity Multiplier 2.14 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 C's superior ROE, as compared with that of Company A's and Company B's ROE, is its greater use of debt financing. The main driver of Company A's inferior ROE, as compared with that of Company C's ROE, is its higher total asset turnover ratio. The main driver of Company C's superior ROE, as compared with that of Company A's and Company B's ROE, is its efficient use of assets.

Answer 1

1: Options 2 and 3

DuPOnt

ROE= PM*TAT * EM

PM is profit margin which measure operating efficiency

TAT is total asset turnover which measures efficiency in the use of assets

EM is equity multiplier which measures financial leverage.

2: Option 1

The main reason why ROE is high in company C is high Equity multiplier. This means that it is using high debt and lower equity in its capital. Option 2 is incorrect since A has a low TAT. Option 3 is incorrect since company C has a higher TAT but not the main driver.