Describe the three components of the DuPont ratio
What will be an ideal response?
Answer: The three components are: operating efficiency, as measured by the profit margin (Net Income/Sales); asset management efficiency, as measured by asset turnover (Sales / Total Assets); and, financial leverage, as measured by the equity multiplier (Total Assets / Total Equity). If we multiply the three ratios, we have return on equity (ROE). The profit margin tells us how much net profit we make for every dollar of sales. The asset management efficiency component tells us how much sales we can get for every dollar invested in assets. The equity multiplier gives us an idea of how much leverage is being used (a higher multiplier indicates more leverage).
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