Question

Compute the Profit margin (PM), asset turnover (AT), and financial leverage (FL) components of the basic Dupont model. Show that ROE=PMxATxFL for 2016. To assets we $45,550 million in 2014. Which component (S) explain the year over year change in Valero's ROE?

Answer 1

THE DUPONT ANALYSIS IA ALSO CALLED AS DUPONT MODEL IN A FINANCIAL RATIO BASED ON THE RETURN ON EQUITY RATIO THAT IS USED TO ANALYSE A COMPANY'S ABILITY TO INCREASE ITS RETURN ON EQUITY.IN OTHER WORDS,THIS MODEL BREEAKS DOWN THE RETURN ON EQUITY RATIO TO EXPLAIN HOW COMPANIES CAN INCREASE THEIR RETURN FOR INVESTORS

AS FROM QUESTION AS WELL AS FROM DUPONT ANALYSIS MAINLY LOOKS AT THREE COMPNENTS:

(1) PROFIT MARGIN

(2)TOTAL ASSET TURNOVER

(3)FINANCIAL LEVERAGE

BASED ON THESE THREE COMPONENTS,WE CAN CONCLUDE THAT A COMPANY CAN RAISE ITS ROE BY MAINTAINING HIGH PROFIT MARGIN,HIGH ASSET TURNOVER WITH HIGH FINACIAL LEVERAGE.

HOWEVER ,SOMETIMES IT IS QUITE POOSIBLE THAT A COMPANY MIGHT HAVE A HIGH ROE DUE TO VERY HIGH PROFIT MARGIN BUT VERY AVERAGE ASSET TURNOVER RATIO.IT HELPS INVESTORS AND EVEN THE MANAGEMENT TO IDENTIFY WHERE THE COMPANY HAS PERFORMED WELL AND WHERE THERE IS A NEED FOR IMPROVEMENT

AS GIVEN ABOVE FORMULA FOR;

ROE =PM*AT*FL

A LITTLE MORE EFFORT HELPS US DISCOVERS ANOTHER IMPORTANT ASPECT THAT IT HAS HOGH OPERATIONG MARGIN I.E,HIGH SALES WITH LOW COST INCURRED,LOWER INTEREST,LOWER INCOME TAX,EFFICIENT USE OF ASSETS(MORE DOLLOR OF REVENUE PER DOLLOR OF ASSET) AND/OR HIGH USE OF DEBT IN ITS CAPITAL STRUCTURE