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what ingredients are in the DuPont model? What is its most important problem?

what ingredients are in the DuPont model? What is its most important problem?

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Answer #1

DuPont model is used to analyse the three different components of RoE (Return on Equity):

= Net margin * Asset turnover ratio * Equity multiplier

Net margin shows operational efficiency, Asset turnover ratio shows asset efficiency and Equity multipler shows the leverage position of the company. This helps understand what contributes most to the Return on Shareholders' Equity.

However, the main drawbacks of the model are as follows:

1. In order to maximize profit, the Management might often engage in accounting manipulations to represent a bright situation in the short term

2. Cost of capital is ignored since it does not take into account the cost of equity (which is higher than the cost of debt)

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