Question

If the DuPont Analysis for Apple (in 2018) is 54.77% and the same analysis for Microsoft (also in 2018) is 39.88%, then...

• Explain how the debt has served to influence the ROE DuPont performance results for each company you choose, and then describe how volatility plays a role in the debt choices in the context of this DuPont analysis. Explore the factors that influence the valuation of equity.

Answer 1

DuPont examines the return on equity analysing profit margin, asset turnover and financial leverage

So formula is ROE = profit margin * asset turnover * leverage

= (Net income/revenue) * (revenue/total assets) * (total assets/shareholders equity)

So, it shows that shareholders equity is determined from total assets less debt and if debt is high then equity is low and results into higher ROE and low amount of debt leads to amount of equity and low ROE.

So we can say that Debt is directly proportional to ROE

In our question, DuPont analysis for apple is 54.77% and for Microsoft, it's 39.88% so debt is lower for company Apple and high for company Microsoft.

Volatility plays a role in the debt choices :- Leverage ratio is the degree to which a corporate uses debt. Debt financing is both beneficial and costly for a firm. In fact, the cost of raising debt is a smaller amount than the cost of raising equity. This impact Is increased by the tax deductibility of interest expenses contrary to none dividend payments and stock repurchases. during this respect, if earnings of debt area unit endowed in comes that have
substantial returns (more than the price of debt), homeowners area unit ready to retain the residual and therefore, the income on equity is "leveraged up." However, accumulation of debt forms a hard and fast payment to be created sporadically by the firm whether or not it's generating operative profit. Therefore, if the company is doing poorly those payments may cut into the equity base. what is more, the risk
of the equity position is increased by the presence of debt holders having a larger claim to the assets of the firm. The leverage number used within the DuPont ratio is explicitly associated with the
proportion of debt in the firm's capital structure.

Fctors that influence the valuation of equity are as follows :-

1) Interest rate

2) Dividend policy

3) Capital structure

4) Economic trends

5) Financial Performance

6) Employment

7) Commodity prices