D demonstrate the application of DuPont analysis of return on equity, and calculate and interpret effects of changes in its components;

Question 1

DuPont Analysis (Alternative impact analysis for leverage, profit margins, turnover on shareholder returns)(Very important, because its breaks down ROA into 3 components: Profit margin, asset turnover, leverage ratio) 3- pnt

Answer 1

DuPont is most useful at ROE decomposition, to see what changes are driving the changes in ROE

DuPont ROE = Net profit margin x asset turnover x leverage ratio

Net Profit margin = NI / Sales
Asset turnover = sales / assets
NI / sales x sales / assets = ROA
Leverage Ratio = assets / equity

In ex on pg 163, DuPont decomp …one will calc ROE;NI / Equity, then DuPont and then compare; Net prof margin (NI/sales) x asset turnover (sales/assets) x leverage ratio (assets/equity)

Ex 164 - if asked to compute ROE via DuPont, check this out ‘Debt - to assets ratio is 60%….DEBT (60%) to…assets…(40%)!! But!! leverage ratio, which is missing, is Assets (DEBT + EQUITY!!! 60 + 40!! OR 1) / EQUITY (40!!) MUAHAHA EASY!

Question 2

5 pnt Dupont

Answer 2

(Tax burden)(Interest Burden)(EBIT Margin)(Asset Turnover)(Financial Leverage)

Tax burden, Int. burden, EBIT margin, FORMALLY KNOWN ASSSSS…NET PROFIT MARGINNN!

Tax burden; NI/EBIT = 1 - Tax rate
Interest Burden; EBT / EBIT
EBIT Margin; EBIT / Revenue

5-point change notes: Increase T or Int burden (aka, decrease in ratios) will tend to decrease ROE. Ex 165-166

*High prof. margins, leverage, and asset turnover lead to high levels of ROE IN GENERAL

but, 5 point includes interest burden which, as leverage rises, burden rises so net increase to ROE isn’t there