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If we know that a firm has a net profit margin of 4.2%, total asset turnover...

If we know that a firm has a net profit margin of 4.2%, total asset turnover of 0.62, and a financial leverage multiplier of 1.37, what is its ROE? What is the advantage to using the DuPont system to calculate ROE over the direct calculation of earnings available for common stockholders divided by common stock equity?

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Answer #1

ROE as per Dupont system = Net profit margin x Total asset turnover x Financial leverage multiplier

= 4.20% * 0.62 * 1.37

= 3.57%

The advantage of Dupont system over a direct calculation is that it povides an insight into each factor that contributes to the ROE of a firm and any factor that is slowing down the ROE can be introspected which would not have been possible under direct calculation. The ROE is decomposed in three important aspects and each aspect can be compared with the targets. Any weakness can be analyzed further and rectified in the due course.  

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