DuPont and sustainable growth

Used to determine what the company is worth, and allows creditors to estimate the company’s ability to pay its existing debt and evaluate their additional debt application.

ROE = net income /equity
(reminders: 1) not subtract preferred dividend 2) use end of year equity but no average)

ROE = (net income/sales) x (sales/equity) = profit margin x equity turnover

Basic DuPont:

ROE = Net margin x Asset turnover x Equity multiplier = (Net income/Sales) x (Sales/Assets) x (Assets/Equity).
(equity multiplier- measure if a company is leveraged)

Extended DuPont:
ROE = [(EBIT/Sales) x (Sales/Assets) - (Interest expense/Assets)] x (Assets/ Equity) x (1 - Tax rate). = {(operating profit margin x total asset turnover – interest expense rate) x financial leverage multiplier x tax retention rate}

As leverage rises, so does the interest expense rate, +ve effects of leverage can be mitigated by the higher interest payments. Higher taxes leads to lower ROE; High profit margin & asset turnover leads to high ROE

Retention rate = 1 - Dividend payout.
(dividend payout = dividends declared / operating income after taxes = Dividend per share / earnings per share)

Sustainable growth rate = ROE x RR = Return on equity x Retention rate.