First Investments Inc owns stock of Basic Industries. Basic Industries is a diversified multinational corporation with major shares in various electrical related markets. Financial Analysis
The financial analysis of the company is carried out using DuPont System of analysis. DuPont Analysis [Ref:4]
There are two methods of DuPont Analysis, one is called three steps and other is called five steps DuPont Analysis. Three Steps DuPont Calculation:
Step 1: Basic equation is very simple i.e.
ROE = net income / shareholders’ equity
Step 2: Taking ROE and multiplying the equation by (Sales/Sales), we get: ROE = (net income / sales) * (sales / shareholder's equity)
ROE = net profit margin * equity turnover ratio
Step 3: Now by multiplying in (assets / assets), we end up with the three-step DuPont identity. ROE = (net income / sales) * (sales / assets) * (assets / shareholder's equity) This equation for ROE breaks it into three widely used and studied components: ROE = (Net profit margin)* (Asset Turnover) * (Equity multiplier) Five Steps DuPont Calculation
Since the numerator of the net profit margin is net income, this can be made into earnings before taxes (EBT) by multiplying the three-step equation by 1 minus the company's tax rate: ROE = (earnings before tax / sales) * (sales / assets) * (assets / equity) * (1 – tax rate) We can break this down one more time, since earnings before taxes is simply earnings before interest and taxes (EBIT) minus the company's interest expense. So, if a substitution is made for the interest expense, we get: ROE = [(EBIT / sales) * (sales / assets) – (interest expense / assets)] * (assets / equity) * (1 – tax rate) The practicality of this breakdown is not as clear as the three-step, but this identity provides us with: ROE = [(operating profit margin) * (asset turnover) – (interest expense rate)] * (equity multiplier) * (tax retention rate) Now...