8. An analysis of company performance using DuPont analysis Walking down the hall of your office building with a sheal of papers in her hand, your friend and colleague, Chloe, stepped into your office and asked the following. CHLOE: 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? CHLOE: I've been reviewing the company's financial statements and looking for general ways to improve our performance, in general, and the company's return on equity, or ROE, in particular. Eric, my new team leader, suggested that I start by using a DuPont analysis, and I'd like to run my numbers and condusions by you, to see if I've missed anything Here are the balance sheet and income statement data that Eric 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. Accounts receivable Inventory Current assets Balance Sheet Data $600,000 Accounts payable 1,200,000 Accruals 1,800,000 Notes payable $3,600,000 Current liabilities Long-term debt Total liabilities Common stock 3,600,000 Retained earnings Total equity $7,200,000 Total debt and equity $720,000 240,000 960,000 $1,920,000 2,400,000 $4,320,000 720,000 2,160,000 $2,880,000 $7,200,000 Income Statement Data Sales $12,000,000 Cost of goods sold 7,200,000 Gross profit $4,800,000 Operating expenses 3,000,000 EBIT $1,800,000 Interest expense 403,200 EBT $1,396,800 Taxes 488,880 Net income $907,920 Net fixed assets Total assets the total asset If I remember correctly, the DuPont equation breaks down our ROE into three component ratios: the turnover ratio, and the 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. In the dropdown lists next to your values I'm going to select correct if your calculation is correct and incorrect if your calculation is incorrect. Ratios Value Value Correct/Incorrect Hydra Cosmetics Inc. DuPont Analysis Correct/Incorrect Ratios Asset management ratio Total asset turnover 1.67 Profitability ratios Gross profit margin (%) Operating profit margin (%) Net profit margin (%) Return on equity (%) 40.00 11.64 12.61 35.10 Financial ratios Equity multiplier 1.67 CHLOE: 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: Note: Do not round intermediate calculations. Round final answers to the nearest whole number. Hydra Cosmetics Inc. DuPont Analysis Calculation Numerator Denominator Value Profitability ratios Gross profit margin (%) Operating profit margin (%) Net profit margin (%) Return on equity (%) Asset management ratio Total asset turnover Financing ratios Equity multiplier CHLOE: I see what I did wrong in my computations. Thanks for reviewing these calculations with me. You saved me from a lot of embarrassment! Eric 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 Hydra'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. Use more debt financing in its capital structure and increase the equity multiplier. Increase the efficiency of its assets so that it generates more sales with each dollar of asset investment and increases the company's total asset turnover. Increase the cost and amount of assets necessary to generate each dollar of sales because it will increase the company's total asset turnover. Increase the firm's bottom-line profitability for the same volume of sales, which will increase the company's net profit margin CHLOE: I think I understand now. Thanks for taking the time to go over this with me, and let me know when I can return the favor. 8. An analysis of company performance using DuPont analysis Walking down the hall of your office building with a sheal of papers in her hand, your friend and colleague, Chloe, stepped into your office and asked the following. CHLOE: 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? CHLOE: I've been reviewing the company's financial statements and looking for general ways to improve our performance, in general, and the company's return on equity, or ROE, in particular. Eric, my new team leader, suggested that I start by using a DuPont analysis, and I'd like to run my numbers and condusions by you, to see if I've missed anything Here are the balance sheet and income statement data that Eric 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. Accounts receivable Inventory Current assets Balance Sheet Data $600,000 Accounts payable 1,200,000 Accruals 1,800,000 Notes payable $3,600,000 Current liabilities Long-term debt Total liabilities Common stock 3,600,000 Retained earnings Total equity $7,200,000 Total debt and equity $720,000 240,000 960,000 $1,920,000 2,400,000 $4,320,000 720,000 2,160,000 $2,880,000 $7,200,000 Income Statement Data Sales $12,000,000 Cost of goods sold 7,200,000 Gross profit $4,800,000 Operating expenses 3,000,000 EBIT $1,800,000 Interest expense 403,200 EBT $1,396,800 Taxes 488,880 Net income $907,920 Net fixed assets Total assets the total asset If I remember correctly, the DuPont equation breaks down our ROE into three component ratios: the turnover ratio, and the 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. In the dropdown lists next to your values I'm going to select correct if your calculation is correct and incorrect if your calculation is incorrect. Ratios Value Value Correct/Incorrect Hydra Cosmetics Inc. DuPont Analysis Correct/Incorrect Ratios Asset management ratio Total asset turnover 1.67 Profitability ratios Gross profit margin (%) Operating profit margin (%) Net profit margin (%) Return on equity (%) 40.00 11.64 12.61 35.10 Financial ratios Equity multiplier 1.67 CHLOE: 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: Note: Do not round intermediate calculations. Round final answers to the nearest whole number. Hydra Cosmetics Inc. DuPont Analysis Calculation Numerator Denominator Value Profitability ratios Gross profit margin (%) Operating profit margin (%) Net profit margin (%) Return on equity (%) Asset management ratio Total asset turnover Financing ratios Equity multiplier CHLOE: I see what I did wrong in my computations. Thanks for reviewing these calculations with me. You saved me from a lot of embarrassment! Eric 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 Hydra'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. Use more debt financing in its capital structure and increase the equity multiplier. Increase the efficiency of its assets so that it generates more sales with each dollar of asset investment and increases the company's total asset turnover. Increase the cost and amount of assets necessary to generate each dollar of sales because it will increase the company's total asset turnover. Increase the firm's bottom-line profitability for the same volume of sales, which will increase the company's net profit margin CHLOE: I think I understand now. Thanks for taking the time to go over this with me, and let me know when I can return the favor