Under the 3-stage DuPont model, what are the three operational and financial components that determine a company's Return on Equity (ROE)?

[ A ]Gross Margin × Current Ratio × Debt Service Coverage Ratio.

[ B ]Net Profit Margin (Profitability) × Total Asset Turnover (Operating Efficiency) × Equity Multiplier (Financial Leverage).[ CORRECT ]

[ C ]Operating Margin × Dividend Payout Ratio × Price-to-Earnings Ratio.

[ D ]Book Value per Share × Earnings Yield × Risk-Free Rate.

Takeaway

The 3-stage DuPont model decomposes ROE into Net Profit Margin (profitability), Total Asset Turnover (operating efficiency), and the Equity Multiplier (financial leverage).

Derivation

ROE = (Net Income/Sales) x (Sales/Total Assets) x (Total Assets/Equity), and multiplying through algebraically collapses back to Net Income/Equity — but the decomposed form reveals WHERE a company's return is actually coming from. A high ROE driven by fat margins is qualitatively different from one driven by aggressive leverage, even if the headline number looks identical, and this distinction matters enormously for risk assessment: leverage-driven ROE carries much higher earnings volatility and solvency risk than margin-driven ROE. This is why the exam repeatedly tests DuPont decomposition — it forces candidates to look past a single summary ratio into its structural drivers.

Why the others fail

A — Gross Margin × Current Ratio × Debt Service Coverage Ratio.

Gross Margin, Current Ratio, and Debt Service Coverage Ratio are three unrelated financial metrics that do not multiply together to reconstruct the ROE identity in DuPont analysis.

C — Operating Margin × Dividend Payout Ratio × Price-to-Earnings Ratio.

Operating Margin, Dividend Payout Ratio, and P/E Ratio do not form the DuPont ROE decomposition; the correct three components are profitability, asset efficiency, and leverage.

D — Book Value per Share × Earnings Yield × Risk-Free Rate.

Book Value per Share, Earnings Yield, and the Risk-Free Rate are valuation and macro inputs, not the three multiplicative components of the DuPont ROE breakdown.