DuPont Analysis and the Decomposition of ROE
An analyst reviews financial ratio data for two companies at the end of the fiscal year.
| Financial Ratio | Company A | Company B |
|------------------------|-----------|-----------|
| Return on Assets (ROA) | 10.9% | 11.0% |
| Return on Equity (ROE) | 25.4% | 14.3% |
| Net Profit Margin | 5.2% | 5.1% |
Company A’s ROE is substantially greater than Company B’s ROE _most likely_ because of its:
Incorrect.
The return on assets (ROA) is just about the same for both companies for this given time period.
Correct.
Recall the DuPont equation that shows return on equity (ROE) and the equation for return on assets (ROA).
ROE = Net profit margin $$\times$$ Asset turnover $$\times$$ Financial leverage
ROA = Net profit margin $$\times$$ Asset turnover
Since ROA and margin are similar for both firms, asset turnover is also similar. The only remaining factor is leverage.
Incorrect.
Company A's net profit margin is only 0.1% higher than Company B's margin.
asset turnover.
net profit margin.
financial leverage.
