Demonstrate, using equations from the Dupont or similar ratio model ...

By Investopedia Staff AAA
Q:
Demonstrate, using equations from the Dupont or similar ratio model, how and why a high-margin business such as an Auto Dealership (AD) can have the same Return on Equity as a low-margin donut shop business (DS).
A:
The key to this question is the relationship between margins and turns in the ROE portion of ratio models and formulas.

ROE = NI/E = Sales/E * NI/Sales

Or in other words,

ROE = Margins * Equity Turns

In the case of this example, assume AD and DS both have a ROE of 12%. From the model:

AD = .24 * .5 = .12 ("Half a turn")

DS = .01 * 12 = .12 ("12 turns")

In other words when generating ROE:
higher margins times lower turns = lower margins times higher turns
(Don't confuse, but relate, turns with returns).

Have a Financial Question?

RELATED FAQS

  1. Who benefits the most from prepaid expenses?

    Learn who benefits most when expenses are prepaid. Individuals and businesses often make payments, such as rent or insurance, ...
  2. If I am looking to get an Investment Banking job. What education do employers prefer? ...

    If you are looking specifically for an investment banking position, an MBA may be marginally preferable over the CFA. The ...
  3. Can I still pass the CFA Level I if I do poorly in the ethics section?

    You may still pass the Chartered Financial Analysis (CFA) Level I even if you fare poorly in the ethics section, but don't ...
  4. The Shur-Gro variable annuity uses an AIR of 3% for those contract holders who are ...

    The correct answer is b. Any time the actual growth rate of the separate account exceeds the account’s AIR, the payment will ...
RELATED TERMS
  1. Personal Financial Advisor

    Professionals who help individuals manage their finances by providing ...
  2. CFA Institute

    Formerly known as the Association for Investment Management and ...
  3. Chartered Financial Analyst - CFA

    A professional designation given by the CFA Institute (formerly ...
  4. Security Analyst

    A financial professional who studies various industries and companies, ...

You May Also Like

Related Articles
  1. No results found.
Trading Center