Question

7. DuPont equation A Aa E 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 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. Sales/ Total Assets Net Income / Sales Total Assets/Total Common Equity

Answer 1

Answer 1:

Correct answer is to check all 3 options as follows:

Sales / Total Assets Net Income / Sales Total Assets / Total Common Equity

Explanation:

DuPont equation:

ROE = Profit Margin * Total Asset Turnover * Equity Multiplier

= Net Income / Sales * Sales / Total Assets * Total Assets / Total Common Equity

As we observe from above equation all 3 factors directly affect company's ROE.

Hence all three options are checked.

Answer 2:

Correct answer is:

The main driver of company C's superior ROE, as compared to that company A's and company B's ROE, is its greater use of debt financing.

Explanation:

As we observe from the table, company C has superior ROE. Profit margin of company C is lower than that of company B. In asset turnover, although company C has slight advantage over company B. But the main driver of company C's superior ROE (as compared to company A and B) is its higher equity multiplier. Higher debt financing results in higher equity multiplier. Hence option C is correct and option B is incorrect.

Option A is incorrect since company A has got lowest equity multiplier implying higher equity and lower debt %age as compared to company B and C.