Can someone break down the 3-step and 5-step DuPont decomposition with a real example?

Question

AcadiFi · Accepted Answer

DuPont analysis is one of the most testable frameworks in CFA Level I FRA because it connects profitability, efficiency, and leverage into a single coherent picture of return on equity.

**3-Step DuPont:**

$$
ROE = 	ext{Net Profit Margin} 	imes 	ext{Asset Turnover} 	imes 	ext{Equity Multiplier}
$$

$$
ROE = \frac{	ext{Net Income}}{	ext{Revenue}} 	imes \frac{	ext{Revenue}}{	ext{Total Assets}} 	imes \frac{	ext{Total Assets}}{	ext{Equity}}
$$

**5-Step DuPont** decomposes net profit margin further:

$$
ROE = 	ext{Tax Burden} 	imes 	ext{Interest Burden} 	imes 	ext{EBIT Margin} 	imes 	ext{Asset Turnover} 	imes 	ext{Equity Multiplier}
$$

$$
ROE = \frac{NI}{EBT} 	imes \frac{EBT}{EBIT} 	imes \frac{EBIT}{Revenue} 	imes \frac{Revenue}{Assets} 	imes \frac{Assets}{Equity}
$$

**Worked Example: Halcyon Consumer Goods**

| Metric | 2025 | 2024 |
|---|---|---|
| Revenue | $840M | $790M |
| EBIT | $126M | $118.5M |
| EBT | $100.8M | $98.7M |
| Net Income | $75.6M | $74.0M |
| Total Assets | $600M | $580M |
| Equity | $240M | $250M |

**3-Step (2025):**
- Net Profit Margin = 75.6/840 = **9.0%**
- Asset Turnover = 840/600 = **1.40x**
- Equity Multiplier = 600/240 = **2.50x**
- ROE = 9.0% x 1.40 x 2.50 = **31.5%**

**5-Step (2025):**
- Tax Burden = 75.6/100.8 = **0.75** (25% tax rate)
- Interest Burden = 100.8/126 = **0.80**
- EBIT Margin = 126/840 = **15.0%**
- Asset Turnover = **1.40x**
- Equity Multiplier = **2.50x**
- ROE = 0.75 x 0.80 x 15.0% x 1.40 x 2.50 = **31.5%**

```mermaid
flowchart TD
    ROE["ROE = 31.5%"] --> NPM["Net Profit Margin
9.0%"]
    ROE --> AT["Asset Turnover
1.40x"]
    ROE --> EM["Equity Multiplier
2.50x"]
    NPM --> TB["Tax Burden
0.75"]
    NPM --> IB["Interest Burden
0.80"]
    NPM --> EBITM["EBIT Margin
15.0%"]
    style ROE fill:#c9a84c,color:#0a0a0f,stroke:#c9a84c
    style NPM fill:#1a1a2e,color:#fff,stroke:#c9a84c
    style AT fill:#1a1a2e,color:#fff,stroke:#c9a84c
    style EM fill:#1a1a2e,color:#fff,stroke:#c9a84c
```

**Why the 5-step matters:** It reveals whether ROE changes are driven by operating efficiency (EBIT margin), financing costs (interest burden), or tax policy (tax burden). If Halcyon's ROE drops next year, the 5-step tells you exactly which lever moved.

**Exam tip:** When a vignette gives you two years of data and asks what drove the ROE change, decompose both years with the 5-step and compare each component. That's the classic CFA Level I item set format.

For more DuPont practice problems, explore our CFA Level I question bank.

Can someone break down the 3-step and 5-step DuPont decomposition with a real example?

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Metric	2025	2024
Revenue	$840M	$790M
EBIT	$126M	$118.5M
EBT	$100.8M	$98.7M
Net Income	$75.6M	$74.0M
Total Assets	$600M	$580M
Equity	$240M	$250M