Du_pont - Finance 254 The DuPont Equation As shareholders in a firm we should be concerned about two things the rate of return we earn on our

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Finance 254 The DuPont Equation As shareholders in a firm, we should be concerned about two things: the rate of return we earn on our invested equity, and of course, the risk associated with this rate of return. The DuPont equation helps us to better understand the former. More specifically, it decomposes the return on equity earned by a firm into three primary factors. It is important to note at the outset that here we are examining the return on equity using book values (net income/common equity) which is wholly different than the holding period return on a share of stock that we have seen recently. The DuPont Equation is: Think about the following situation: you lend money to a friend to start a lemonade stand. When you lend the money, you say that you don’t need the money back if the business fails, but if it succeeds, you want a share of the profits. This is the situation of investing equity in a business. Now consider what factors would affect the amount of money you receive as profits, and hence the return on your invested equity. Profitability
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This note was uploaded on 09/19/2009 for the course FIN FIN 221 taught by Professor Fin221 during the Fall '09 term at University of Illinois, Urbana Champaign.

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