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Lec. 7

The DuPont analysis dissects a firm's financial statements to assess its financial condition through profitability measures like return on total assets (ROA) and return on equity (ROE). It combines net profit margin and total asset turnover to calculate ROA, and then relates ROA to ROE using the financial leverage multiplier. Market ratios such as the Price/Earnings (P/E) and Market/Book (M/B) ratios indicate the firm's low growth opportunities and high risks compared to industry averages.

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4 views8 pages

Lec. 7

The DuPont analysis dissects a firm's financial statements to assess its financial condition through profitability measures like return on total assets (ROA) and return on equity (ROE). It combines net profit margin and total asset turnover to calculate ROA, and then relates ROA to ROE using the financial leverage multiplier. Market ratios such as the Price/Earnings (P/E) and Market/Book (M/B) ratios indicate the firm's low growth opportunities and high risks compared to industry averages.

Uploaded by

michaelmofdy209
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We take content rights seriously. If you suspect this is your content, claim it here.
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DuPont Analysis

The DuPont system of analysis is used to dissect the firm’s financial statements
and to assess its financial condition. It merges the income statement and balance sheet
into two summary measures of profitability, return on total assets (ROA) and return on
common equity (ROE).
The DuPont system first brings together the net profit margin, which measures
the firm’s profitability on sales, with its total asset turnover, which indicates how
efficiently the firm has used its assets to generate sales. In the DuPont formula, the
product of these two ratios results in the return on total assets (ROA):

ROA = Net profit margin × Total asset turnover

Earnings available for common stockholders Sales


𝑅𝑂𝐴 = ×
Sales Total assets
ROA = 7.2% × 0.85 = 6.1%
The second step in the DuPont system employs the modified DuPont formula. This
formula relates the firm’s return on total assets (ROA) to its return on equity (ROE).
The latter is calculated by multiplying the return on total assets (ROA) by the financial
leverage multiplier (FLM), which is the ratio of total assets to common stock equity:

ROE = ROA × financial leverage multiplier

ROE = Net profit margin × Total asset turnover × financial leverage multiplier
Earnings available for common stockholders Sales Total assets
𝑅𝑂𝐸 = × ×
Sales Total assets common stockholders 𝑒𝑞𝑢𝑖𝑡𝑦

ROE = 7.2% × 0.85 × 2.06 = 12.6%


Market ratios relate the firm’s market value, as measured by its current share
price, to certain accounting values.
Price / Earnings (P/E) ratio = Market price per share of common stock ÷ Earnings
per share

32.25 ÷ 2.90 = 11.12


This figure indicates that investors were paying $11.12 for each $1.00
of earnings, compared to the industry average (13.3 times), we find that
the firm's position is bad, because this is an indicator of the firm's low
growth opportunities, as well as its high risks compared to the industry.
Market / Book (M/B) ratio = Market price per share of common stock ÷ Book value
per share of common stock

32.25 ÷ 23.00 = 1.40


This figure indicates that investors were paying $1.40 for each $1.00
of book value, compared to the industry average (2.10 times), we find
that the firm's position is bad, because this is an indicator of the firm's
low growth opportunities, as well as its high risks compared to the
industry.

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