Dissecting return on equity with DuPont analysis

The case and its answers

Every question of this case, with its answer and why each other option is wrong.

Orbit Industries reports net profit of ₹60 crore and sales of ₹1,200 crore for the year. Average total assets are ₹600 crore and average ordinary shareholders’ equity is ₹300 crore. Use averages for both balance-sheet denominators and assume all profit belongs to ordinary shareholders. A comparator earns the same net margin and asset turnover but uses an equity multiplier of 1.5 rather than Orbit’s multiplier. The analyst uses the three-part DuPont identity: net margin × asset turnover × equity multiplier. There are no exceptional profits, minority interests or changes in accounting definitions between the two companies.

All people, firms, prices and contract terms are fictional.

Ignore taxes and transaction costs unless the case explicitly includes them.

1. Q1What is Orbit’s net profit margin?

   • A

     Option A. 10%

     Why it is wrong: This divides profit by assets, giving return on assets.

   • B

     Option B. 20%

     Why it is wrong: This divides profit by equity, giving ROE.

   • C

     Option C. 5% — Correct answer

   • D

     Option D. 50%

     Why it is wrong: This overstates the profit-to-sales ratio.

   Answer: C. ₹60 crore ÷ ₹1,200 crore × 100 = 5%. Remember: A margin compares a profit measure with the revenue that produced it.

   Hint, shown before you answer in practice mode: Use net profit divided by sales.

   XV-S2-C01-Q1easynumerical

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2. Q2What is Orbit’s asset turnover?

   • A

     Option A. 2 times — Correct answer

   • B

     Option B. 4 times

     Why it is wrong: This divides sales by equity rather than total assets.

   • C

     Option C. 0.50 times

     Why it is wrong: This reverses assets and sales.

   • D

     Option D. 1 time

     Why it is wrong: Sales and assets are not equal.

   Answer: A. ₹1,200 crore ÷ ₹600 crore = 2 times. Remember: Asset turnover measures revenue generated per unit of assets.

   Hint, shown before you answer in practice mode: Divide annual sales by average assets.

   XV-S2-C01-Q2mediumnumerical

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3. Q3What is Orbit’s ROE under the supplied averages?

   • A

     Option A. 20% — Correct answer

   • B

     Option B. 40%

     Why it is wrong: This uses an excessive leverage multiplier.

   • C

     Option C. 10%

     Why it is wrong: This is return on assets before applying the equity multiplier.

   • D

     Option D. 5%

     Why it is wrong: This is net margin.

   Answer: A. ₹60/₹300 × 100 = 20%. Equivalently, 5% × 2 × (600/300) = 20%. Remember: DuPont links profitability, asset use and financial leverage.

   Hint, shown before you answer in practice mode: Either divide profit by equity or multiply the three DuPont terms.

   XV-S2-C01-Q3mediumnumerical

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4. Q4What ROE would the comparator have with the same margin and turnover but a 1.5 equity multiplier?

   • A

     Option A. 30%

     Why it is wrong: This doubles the correct result.

   • B

     Option B. 20%

     Why it is wrong: This retains Orbit’s multiplier of 2.

   • C

     Option C. 15% — Correct answer

   • D

     Option D. 7.50%

     Why it is wrong: This omits asset turnover.

   Answer: C. 5% × 2 × 1.5 = 15%. Orbit’s higher ROE in this comparison comes from greater leverage, not better operating margin or turnover. Remember: A higher ROE can reflect financing structure rather than stronger operating performance.

   Hint, shown before you answer in practice mode: Change only the leverage term in the identity.

   XV-S2-C01-Q4mediumnumerical

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