Intermediate Financial Reporting 1 Practice Exam

DuPont analysis breaks ROE into three distinct drivers: profitability, efficiency, and leverage. Net Profit Margin shows how much profit the company keeps from each dollar of sales, Asset Turnover measures how effectively assets generate sales, and the Leverage Multiplier (Equity Multiplier) reflects how financial leverage increases returns on shareholders’ equity. When you multiply these three components together, you get ROE: Net Profit Margin × Asset Turnover × Leverage Multiplier. If you expanded it, you’d have Net Income / Revenue × Revenue / Average Total Assets × Average Total Assets / Average Shareholders’ Equity, which simplifies back to Net Income / Average Shareholders’ Equity (ROE). The expression that combines all three drivers is the correct DuPont form. The other options either omit a driver or represent a different metric (for example, Net Income divided by Average Total Assets is ROA, not ROE, and doesn’t show the leverage effect).