Question

What do you think some of the advantages and/or disadvantages to using the DuPont Identity as a tool for calculating ROE?

Class: MBA615 Managerial Finance.

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Answer 1

DuPont identity breaks down the Return on Equity into its components so that each can be examined in depth. It is the financial ratio used to analyze the company's ability to increase its return on equity.

Advantages

Disadvantages

It provide the fuller picture of a company’s financial health and performance compared to more limited equity valuation tools. It is helpful for investors to make more informed choices regarding their equity holding. DuPont identity analysis 3 important performance elements- profitability, operational efficiency, financial leverage. It provide more accurate assessment of the significance of change in company’s ROE. DuPont analysis help the investors pinpoint the sources of increased or decreased equity returns.

The DuPont model relies on accounting data from financial statement of the company which can be manipulated, so there are chances that they may not be accurate. It requires several inputs which increase its costs and makes it expensive in nature. The quality of result is depend on the nature and quality of the input provided. Though data is reliable, may be additional potential problems such as difficulty in determining relative values of ratios. Financial ratios are always best evaluated on comparison basis, whether with closet business company or with its own historical performances.

References- Investopedia, Charted accountant study material for Financial management