Financial

Module 4: Discussion Forum

Using DuPont analysis is a quick and relatively easy way to assess the overall health of a firm.This weeks lesson (Page 4) includes information on the DuPont equation.Go to finance.yahoo.com and choose a company by entering the company name in the box to the left of Get Quotes.Once you have the company overview page open, to the left you will see a list of links for further information on that firm. Near the bottom of the link column are financial statements. Open the firms income statement and balance sheet and use the information there to calculate all parts of the DuPont Ratio for the past three years; do not use Nike.If your firm does not have 3 years of full information, choose a different firm. Report each ratio value as well as the numerator and denominator of each of the 4 ratios for the past 3 years (12 ratios in total). Discuss the trends revealed in each ratio. Please be sure to note your firms name in the title of your post and please do not duplicate firms. Your instructor is posting information on Nike as an example; you might want to study that post before you begin.

Your instructor is likely to have questions/comments on your original post so be sure to be prepared for those potential questions.

Page 4 infromation

4. DuPont Analysis

Your text refers to the DuPont return on assets; however, DuPont took his ratio further to capture return on equity. DuPont's identity states that return on equity is equal to return on assets, times an equity multiplier; the equity multiplier is defined as total assets divided by total equity. Stockholders are very interested in a firm’s return on equity and a rising ratio is desirable. DuPont stated that return on equity is a function of the firm’s success in (1) reducing costs (measured by net profit margin), (2) using assets efficiently (measured by total asset turnover), and (3) using debt effectively (measured by the equity multiplier). 

In simple terms, the DuPont equation for Return on Equity is the following.

ROE = NPM * TAT * EM
.
Where:	ROE = return on equity (in simpler form) = Net income/Total stockholders’ equity
	NPM = net profit margin (in simpler form) = Net income/Total revenues
	TAT = total asset turnover (in simpler form) = Total revenues/Total assets
	EM = equity multiplier = 1+Debt/Equity

Net profit margin was studied in Module 3 and should be reviewed if needed. Total asset turnover, generally expressed as a whole number, tells how much revenue is generated with each dollar spent on assets. If Firm A has an asset turnover of 2.0 while its competitor, Firm B, has an asset turnover of 2.5, the analyst concludes that Firm B is using its assets more efficiently than Firm A. In times of expansion, the asset turnover may decline; however, in the long-run, analysts want to see this ratio rising. 

The equity multiplier, expressed as a whole number, gives the analyst a sense of how reliant a firm is on debt; i.e. how effectively the firm uses leverage. A high equity multiplier implies that the firm relies heavily on debt as a source of capital. While some students tend to think that debt is “bad,” this is not true. Because interest is tax-deductible (and dividend payments are not), debt is a cheap source of funding and as long as the firm is able to handle its debt payments, debt is a “good” choice. By increasing debt, the firm adds leverage and magnifies return on equity. Of course, there is a risk of increasing debt too far and finding a balance is important. 

When analyzing a firm’s return on equity using the DuPont equation, time-series analysis and cross-sectional analysis are important. Students will be asked to perform a time-series analysis of the DuPont equation in this week’s discussion board.