DuPont Equation Question

CFA Level I FRA
#1

I’m either not understanding something or am reading a typo and need clarification please!

Re: Interest Burden - The statment reads “An increase in interest expense as proportion of EBIT will INCREASE the interest burden.”

Since EBT/EBIT = interest burden, then increasing interest expense as a percentage of EBIT will give a LOWER EBT and thus a Lower EBT and thus a LOWER Interest Burden.

Am I missing something or should it read "An increase in interest expense as a proportion of EBIT will DECREASE the interest burden?

I thought Tax Burden = 1-Tax Rate and Interest Burden = 1-Interest Rate. If so, wouldn’t and increase to either the tax rate or Interest rate DECREASE the Tax Burden and Interest burden? Not sure why I am so confused with this.

Any help/clarity would be greatly appreciated!!

#2

Where did you read this?

The definitions aren’t intuitive:

  • EBT / EBIT is the interest burden , which _ decreases _ as interest expense increases; it would make more sense to call (1 – (EBT / EBIT)) interest burden (because this increases as interest expense increases).
  • Net Income / EBT is the tax burden , which _ decreases _ as tax expense increases; it would make more sense to call (1 – (Net Income / EBT)) tax burden (because this increases as tax expense increases).

Alas, we’re stuck with these stupid definitions.

#3

Thanks! The terms are a little counter intuitive to me in this case and I agree with you. In this case I will just have to get use to the this and “view things differently” here. It just seems logical (in my brain anyways) that a higher tax rate would lead to a higher tax expense and thus a higher tax burden. However, I am learning that a higher tax rate leads to a higher tax expense and lower ratio (NI / EBT) and thus a “Higher Tax Burden.” The same applies with regards to the Interest Burden.

Am I correct and does that make sense? Thanks again!

I was studying out of a previous years SchweserNotes book I have. I guess it’s accurate. Sometimes we just have to read and reread until it sinks in and we comprehend. agh… :slight_smile: