Question

A model used to decompose a firm return of equity is the

Answer 1

DuPont Analysis/Equation

DuPont equation breaks ROE into three components which help the investor/analyst to understand the ROE of the company under analysis better.

There are 2 versions of DuPont model - one is the original 3 factor model and other is a 5 factor model.

According to 3 factor model:

ROE = Net Profit Margin * Total Asset Turnover * Equity Multiplier

This equation can help one to understand what is driving ROE up or down.

A more recent version, the 5 factor model, breaks net profit margin into 3 factors:

ROE = Operating Profit Margin * Interest Burden * Tax Efficiency * Total Asset Turnover * Equity Multiplier