DuPont Analysis (20.4)

Question 1

Describe Dupont analysis, what does it analyze?

Answer 1

The DuPont system of analysis is an approach that can be used to analyze return on equity (ROE). It uses basic algebra to break down ROE into a function of different ratios, so an analyst can see the impact of leverage, profit margins, and turnover on shareholder returns.

Question 2

What are the two variants of the DuPont system?

Answer 2

There are two variants of the DuPont system: The original three-part approach and the extended five-part system.

Question 3

What’s another name for the leverage ratio

Answer 3

The leverage ratio is sometimes called the “equity multiplier.”

Question 4

What is the original DuPont equation?

Answer 4

return on equity = net profit margin × asset turnover × leverage ratio
or:
return on equity=(net income/revenue)(revenue/average total assets)(average total assets/equity)

Based on this, If ROE is relatively low, it must be that at least one of the following is true: The company has a poor profit margin, the company has poor asset turnover, or the firm has too little leverage.

Answer 5

ROE=(net income/EBT)(EBT/EBIT)(EBIT/revenue)(revenue/average assets)(average assets/average equity)

Note that the first term in the 3-part DuPont equation, net profit margin, has been decomposed into three terms. The second two (asset turnover and leverage) remain the same as the 3 part system.

*Note:
net income/EBT is called the tax burden and is equal to (1 – tax rate).
EBT/EBIT is called the interest burden.
EBIT/revenue is called the EBIT margin.

We then have:
ROE=(taxburden)(interestburden)(EBITmargin)(assetturnover)(financialleverage)