Module 24.4 DuPont Analysis

Question 1

What is the original calculation of return on equity?

Answer 1

net income / average equity

Question 2

What is the formula for return on equity if provided with the equity turnover?

Answer 2

net profit margin * equity turnover

Question 3

What is the formula for return on equity if provided with the leverage ratio or “equity multiplier” and the asset turnover rather than equity turnover?

Answer 3

net profit margin * asset turnover * leverage ratio

Question 4

If ROE is relatively low, what must that mean in terms of the DuPont Analysis?

Answer 4

it must mean poor profit margin, poor asset turnover, or too little leverage.

Question 5

What is the extended 5-way DuPont equation?

Answer 5

(net income / EBT) * (EBT / EBIT) * (EBIT / Revenue) * (revenue / average asset) * (average assets / average equity)

Question 6

What is the difference between the 3 point and 5 point DuPont formula?

Answer 6

The first part “net profit margin” is broken out into three:

1) Net income / EBT = tax burden. Can also be calculated by (1 - tax rate)
2) EBT / EBIT = interest burden
3) EBIT / Revenue = EBIT Margin

Question 7

Will an increase in interest expense in proportion to EBIT decrease ROE?

Answer 7

Yes - increases in either the tax burden or interest burden will decrease ROE.

Question 8

Does the 5-way DuPont equation prove that higher leverage always leads to higher ROE?

Answer 8

No, because as leverage rises so does the interest burden.