Question

The return on equity (ROE) is an important ratio to investors. Discuss each part of the DuPont Identity as it relates to the ROE. Discuss the type of information that the DuPont Identity reveals compared to the ROE considered alone. What can increase or decrease the ROE?

Answer 1

Du Point Identity- It tells how the return on equity (ROE) can be used in three other ratios: Profit margin, Total assets turnover and Equity multiplier. Du point analysis is a measure of performance of the company.

Formula: REO = Profit margin * Asset turnover * Equity multiplier

Parts of Du Point identity: Are as following-

Profit margin- This is a measure of operating efficiency. Its formula is:

Net Income / Sales

Asset Turnover- This is a measure of efficiency of assets. Its formula is:

Sales / Total Assets

Equity Multiplier- This is a measure of financial leverage. Its formula is:

Total Assets / Shareholder's equity

Information that the DuPont Identity reveals- It reveals the point which is affecting return on equity. It traces the cause why ROE is declining. It also tells the main driver that is increasing company's ROE.