Chapter 2: Q3-2DQ (page 74)

Explain how the Du Pont system of analysis breaks down return on assets. Also explain how it breaks down return on stockholders’ equity

Short Answer

Expert verified

With the Du Pont system of analysis,the return on assets is calculated by multiplying the net profit margin with the total assets turnover. Andthe return on the stockholder’s equity is calculated by multiplying the return on the asset with the equity multiplier.

Step by step solution

Step: Definition

The Du Pont analysis breaks down the equation of Return on Equity (ROE) into three parts:

Profitability is measured by the profit margin(Net income/Revenue)
Asset efficiency is measured by asset turnover(Revenue/Average Total Assets)
Financial leverage is measured by the equity multiplier(Average Total Assets/Average Total Equity)

Step: By the Du Pont system, return on assets is broken down as

$R e t u r n o n A s s e t s (R O A) = P r o f i t m a r g i n \times A s s e t t u n o v e r = \frac{N e t i n c o m e}{S a l e s} \times \frac{S a l e s}{A v e r a g e T o t a l A s s e t s} = \frac{N e t i n c o m e}{A v e r a g e T o t a l A s s e t s}$

Step: By the Du Pont system, the return on stockholder’s equity is broken down as

$R e t u r n o n e q u i t y (R O E) = P r o f i t m a r g i n \times A s s e t t u n o v e r \times E q u i t y M u l t i p l i e r = \frac{N e t i n c o m e}{S a l e s} \times \frac{S a l e s}{A v e r a g e T o t a l A s s e t s} \times \frac{A v e r a g e T o t a l A s s e t s}{A v e r a g e T o t a l E q u i t y} = \frac{N e t i n c o m e}{A v e r a g e T o t a l E z u i t y}$

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	20X1	20X2
Sales	\(3,230,000	\)3,370,000
Cost of goods sold	2,130,000	2,850,000
Gross profits	\(1,100,000	\)520,000
Selling and administrative expenses	298,000	227,000
Operating profits	\(802,000	\)293,000
Interest expense	47,200	51,600
Income before taxes	\(754,800	\)241,400
Taxes (35%)	264,180	84,490
Income after tax	\(490,620	\)156,910

Increase in accounts receivable	Decrease in prepaid expenses
Increase in notes payable	Increase in inventory
Depreciation expense	Dividend payment
Increase in investment	Increase in accrued expenses
Decrease in account payable

Explain how the Du Pont system of analysis breaks down return on assets. Also explain how it breaks down return on stockholders’ equity

Short Answer

Step by step solution

Step: Definition

Step: By the Du Pont system, return on assets is broken down as

Step: By the Du Pont system, the return on stockholder’s equity is broken down as

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