# The DuPont formula relates return on equity (= net income

advertisement
```DUPONT ANALYSIS: Company V. Industry
The DuPont formula relates return on equity (= net
income &divide; Stockholders equity) to the company's net
profit margin (= net income &divide; sales), asset turnover (=
sales &divide; total assets), and equity multiplier (= total assets
&divide; common equity). This Company is in an industry
where the average net profit margin is 5.65%, the debt-toasset ratio (= total debt &divide; total assets) is 36.8%, and
return on equity is 37.04%. For the company, the
numbers are
Balance Sheet, 12/31/2525
cash
PP&amp;E
2050
5000
7050
debt
SE
Income 1/1 - 12/31/2525
2650 sales
40890
4400 tot. costs 38600
7050 net income 2290
Use financial ratios to explain why the company's
return-on-equity differs from its industry average.
{ANSWER: Prepare a small table to describe the situation:
ratio
company
industry
5.60%
5.65%
profit margin
37.6%
36.8%
debt ratio
5.80
4.14
asset turnover
52%
37%
ROE
The profit margin computation is straightforward (= net income &divide; sales), as
is the debt-to-total assets ratio. The company asset turnover ratio is
straightforward (=sales &divide; total assets) but for the industry you must compute
the asset turnover from the dupont relation:
return-on-equity = (net profit margin) x (asset turnover) x (equity multiplier)
The equity multiplier, (=total assets &divide; stockholders equity), is exactly
identical to 1/(1- debt-to-total assets.). Because the industry debt-to-total
assets ratio is given as 36.8%, then the equity multiplier is 1.5823.
Find the industry asset turnover as:
0.3704 = (.0565) x (asset turnover) x (1.5823),
or asset turnover = 4.14. This company ratio differs a lot from the industry
average. The company's ROE is bigger than the average firm in the industry
because the company gets more sales per dollar of assets. Maybe they carry
very little inventory or rely on labor more than on PP&amp;E.
```