8. An analysis of company performance using DuPont analysis A sheaf of papers in her hand, your friend and colleague, Madison, steps into your office and asked the following. MADISON: Do you have 10 or 15 minutes that you can spare? YOU: Sure, I've got a meeting in an hour, but I don't want to start something new and then be interrupted by the meeting, so how can I help? MADISON: I've been reviewing the company's financial statements and looking for ways to improve our performance, in general, and the company's return on equity, or ROE, in particular. Xavier, my new team leader, suggested that I start by using a DuPont analysis, and I'd like to run my numbers and conclusions by you to see whether I've missed anything. Here are the balance sheet and income statement data that Xavier gave me, and here are my notes with my calculations. Could you start by making sure that my numbers are correct? YOU: Give me a minute to look at these financial statements and to remember what I know about the DuPont analysis. Balance Sheet Data Income Statement Data Cash $1,300,000 Accounts payable $1,560,000 Sales Accounts receivable 2,600,000 Accruals 520,000 Cost of goods sold Inventory 3,900,000 Notes payable 2,080,000 Gross profit Current assets 7,800,000 Current liabilities 4,160,000 Operating expenses Long-term debt 6,760,000 EBIT Total liabilities 10,920,000 Interest expense Common stock 1,170,000 EBT Net fixed assets 7,800,000 Retained earnings 3,510,000 Taxes Total equity 4,680,000 Net income Total assets. $15,600,000 Total debt and equity $15,600,000 , the total asset If I remember correctly, the DuPont equation breaks down our ROE into three component ratios: the turnover ratio, and the i And, according to my understanding of the DuPont equation and its calculation of ROE, the three ratios provide insights into the company's effectiveness in using the company's assets, and Now, let's see your notes with your ratios, and then we can talk about possible strategies that will improve the ratios. I'm going to check the box to the side of your calculated value if your calculation is correct and leave it unchecked if your calculation is incorrect. $26,000,000 13,000,000 13,000,000 6,500,000 6,500,000 1,060,800 5,439,200 1,359,800 $4,079,400 Canis Major Veterinary Supplies Inc. DuPont Analysis Ratios Value Correct/Incorrect Ratios Value Correct/Incorrect Profitability ratios Asset management ratio Gross profit margin (%) 50.00 Total assets turnover 1.67 Operating profit margin (%) 20.92 Net profit margin (%) 26.15 Financial ratios Return on equity (%) 62.45 Equity multiplier 1.43 MADISON: OK, it looks like I've got a couple of incorrect values, so show me your calculations, and then we can talk strategies for improvement. YOU: I've just made rough calculations, so let me complete this table by inputting the components of each ratio and its value: Do not round intermediate calculations and round your final answers up to two decimals. Canis Major Veterinary Supplies Inc. DuPont Analysis Ratios Calculation. Value Profitability ratios Numerator Denominator Gross profit margin (%) Operating profit margin (%) Net profit margin (%) Return on equity (%) Asset management ratio Total assets turnover Financial ratios Equity multiplier 1 MADISON: I see what I did wrong in my computations. Thanks for reviewing these calculations with me. You saved me from a lot of embarrassment! Xavier would have been very disappointed in me if I had showed him my original work. So, now let's switch topics and identify general strategies that could be used to positively affect Canis Major's ROE. YOU: OK, so given your knowledge of the component ratios used in the DuPont equation, which of the following strategies should improve the company's ROE? Check all that apply. Decrease the company's use of debt capital because it will decrease the equity multiplier. Use more equity financing in its capital structure, which will increase the equity multiplier. Increase the interest rate on its notes payable or long-term debt obligations because it will reduce the company's net profit margin. Increase the efficiency of its assets so that it generates more sales with each dollar of asset investment and increases the company's total assets turnover. MADISON: I think I stand now. Thanks for taking the time to go over this with me, and let me know when I can return the favor. 0