The "DuPont Equation" breaks down the ROE, (Return on Equity), into 3

components:
1. Profit Margin
2. Asset Turnover
3. Leverage

The DuPont Equation is [Profit Margin x Total Asset Turnover x Equity

Multiplier]
The Equity Multiplier is the relationship of total assets to total equity
o

At this point, I want you to remember the basic balance sheet

formula: Assets = Liabilities + Equity
Alternatively we can say Assets - Liabilities = Equity

By remembering our basic balance sheet formula, immediately we can see that the
Equity Multiplier indirectly incorporates debt into the equation, (debt is an
underlying factor in total assets - again look at the basic balance sheet formula).
The intention of this multiplier is to ascertain how "leveraged" the company is. In
other words, how much of the assets are financed with debt versus equity.
ROE or Return on Equity is the rate of return for ownership, (as a %), - in other
words, how much money or value is generated for investors once expenses are
paid. To calculate this ratio, we use Net Income/Total Shareholder's Equity. Without
looking into this relationship further, we cannot ascertain which components are
functioning well and which are not - we just have an overall picture of performance
that may not provide adequate information. For instance, if this rate increases, how
do we know if it's because the company increased their profit margin or increased
their debt?
Now if we look at the equation Jeff listed above - the components of the standard
DuPont Equation I listed above are "extended" in that we break out 2 additional
components of Net Income:
1. Interest
2. Taxes
Why do we break out these additional components? The purpose is to examine the
impact of taxes and interest on net income. If a company takes on additional debt
to finance assets, this will negatively impact net income. Additionally, different
companies may have different tax advantages. By understanding the tax efficiency,
we can determine the impact taxes have on net income as well.

For the purposes of this class, you may use the following DuPont
formula:
[PROFIT MARGIN] x [ASSET TURNOVER RATIO] x [EQUITY
MULTIPLIER]
Where the Equity Multiplier is expressed, (extended), as
follows:

o 1 / (1-debt ratio) where the debt ratio = Total

Assets/Total Debt
I know there are many variations of the Extended DuPont Equation available
and if you are comfortable enough to use a more extended version, you may
do so, however, the above equation will be considered satisfactory for our
purposes.