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DuPont Identity

30 April, 2015 - 10:29

The DuPont Identity is a financial tool that can be used to see how three main factors affect ROE:

Profit Margin - Net Profit/Sales

Asset Turnover - Sales/Assets

Leverage Ratio - Assets/Equity

ROE = \frac{Net Profits}{Sales} * \frac{Sales}{Assets} * \frac{Assets}{Equity}

Suppose XYZ Corp. has a profit margin of 20%, asset turnover of 300%, and a leverage ratio of 50%. What would their return on equity be?

We can see that this relatively simple calculation is:

ROE = .2 * 3 * .5 = 30\%

The DuPont Identity allows us to see that ROE is a complex measure. A company with a low profit margin may have a strong ROE if it is not levered up very much. The equation can be rearranged to solve for missing values, as in the following example:

Suppose ABC Corp. has a 10% profit margin, an ROE of 30%, sales of $2000, and equity of $1000. What is the value of its assets?

By plugging in the values given, we can solve for assets = $500

.3 = .15 * \frac{2000}{x} * \frac{x}{1000}

x = 500