101 1164ae00b0000&ctx-igriffit-0035;&ck-m; 15281653382 uation Corporate decision
ID: 1170663 • Letter: 1
Question
101 1164ae00b0000&ctx-igriffit-0035;&ck-m; 15281653382 uation Corporate decision makers and analysts often use a technique called DuPont analysis to understand and assess the factors that drive a company's financial performance, as measured by its return on equity (ROE). Depending on the version used, the DuPont equation will the firm's ROE, its best measure of financial performance, into two or three important factors, or drivers DuPont analysis can be conducted using either the traditional DuPont equation or the extended DuPont equation. The traditional equation is constructed using two drivers, whereas the extended DuPont equation uses three variables to examine a firm's ROE performance. Complete the following sentences by entering the appropriate words or phrases. In the extended DuPont equation, a firm's ROE reflects (1) its use of debt financing, or leverage, as reflected by its (2) the efficiency with which it uses its assets, as measured by the its production costs and operating expenses, as summarized by its , and (3) its ability to generate safes and manage In contrast, in the traditional version of the equation, the firm's efficiency and profitability metrics are multiplied and summarized in a singe measure, the financing decisions and its effectiveness and efficiency in generating profits using the firm's asset base. In this analysis, a company's financial performance is expected to result from both management's Most investors and analysts in the financial community observe a firm's ROE closely. The ROE can be calculated by dividing the firm's net income by the shareholders' equity, or it can be reduced into the key factors that drive the ROE. Investors and analysts like to focus on these drivers to develop a more holistic image of what is changing within a company. An analyst collected the following fiscal year 2010 data for firms operating in the transportation sector, Use the data to compute the net profit margin (NPM), total asset turnover (TAT), and equity multiplier (EM) values required for a DuPont analysis. (Note: The following dollar values are expressed in millions of U.S. dollars.) Net Total CommonExplanation / Answer
(1) Equity Multiplier
(2) Asset Turnover ratio
(3) Net Profit Margin.
(4) Return on Assets
Let us explain the same using the Du Pont's Equation:
Du Pont's relation is expressed as:
Return on Equity (ROE) = Net Profit Margin x Asset Turnover Ratio x Equity Multiplier
Each of the terms can be further expressed as ratios of financial statement components as:
Return on Equity (ROE) = (Net Income / Average Shareholders' Equity) = (Net Income / Total Revenue) x (Revenue / Average Total Assets) x (Average Total Assets / Average Shareholders' Equity)
Net Income/Total Revenue - explains the company's cost management, Revenue/Total assets - explains company's ability to use assets efficiency to generate sales and Average total assets/shareholders' equity - explains the amount of debt/equity used by company to finance its assets.
When you multiply the cost management efficiency (Net Profit Margin) and Asset Turnover (asset usage efficiency), it is Return on Assets.
(Net Income/Sales) * (Sales/Total Assets) = Net Income/Total Assets = ROA
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