Lecture 1 Du Pont Identity.

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Presentation transcript:

Lecture 1 Du Pont Identity

Financial ratios ROA = NI / A ROE = NI / E where ROA = Return on Assets ROE = Return on Equity NI = Net Income A = Total Assets E = Total Equity

1. Du Pont Identity (DPI) for ROA Start with ROA = NI/A Multiply and divide the right-hand-side by S/S:

Numerical Example Information given: NI/S = 0.1 S/A = 2

What is S/A?

2. DPI for ROE ROE = NI/E Multiply and divide the right-hand-side by S/S Multiply and divided the right-hand-side by (A/A)

Variables in ROE

One step further Balance Sheet Identity: A = D + E where A = Total Assets D = Total Debt E = Total Equity

One step further (cont.)

Summary ROA Du Pont Identities: 1. ROA = NI/A 2. ROA = (NI/S) x (S/A) 3. ROA = Profit margin x Asset use efficiency

Summary ROE Du Pont Identities: ROE = NI/E ROE = (NI/S) x (S/E) ROE = (NI/S) x (S/A) x (A/E) ROE = Profit margin x Asset use efficiency x Equity multiplier ROE = ROA x (A/E) ROE = (NI/S) x (S/A) x (1 + D/E) ROE = Profit margin x Asset use efficiency x (1 + Debt-equity ratio)

What does it mean? ROA = Profit margin x Asset use efficiency x (1 + Debt-equity ratio)

Numerical Example ROA calculation Given the following information: Net Income = $1,000 Total Assets = $10,000 Sales = $15,000 Calculate the return on assets.

Numerical Example ROE calculation Given the following information: Profit margin = 8% Sales = $20,000 Total Assets = $50,000 Total Equity = $30,000 Net Income = $1,600 What is the return on equity?

Numerical Example Calculation of missing variables given ROE Given the following information: Profit margin = 8% Total equity = $30,000 Net Income = $5,000 ROE = 16.67% Asset use efficiency = 0.5 What is total debt, D?

Missing variable

Practice, Practice, Practice Information given: Net Income = $5,000 Sales = $62,500 Total Assets = $125,000 Total Equity = $30,000 Total Debt = $95,000 ROE = 16.67%