8. The DuPont equation Corporate decision makers and analysts often use a particular technique, called a DuPont analysis, to better understand the factors that drive a company's financial performance, as reflected by its return on equity (ROE). By using the DuPont equation, which disaggregates the ROE into three components, analysts can see why a company's ROE may have changed for better or worse and identify particular company strengths and weaknesses. The DuPont Equation A DuPont analysis is conducted using the DuPont equation, which helps to identify and analyze three important factors that drive a company's ROE. According to the equation, which of the following factors directly affect a company's ROE? Check all that apply. Market-to-book-value ratio Financial leverage Efficiency in use of total assets Most investors and analysts in the financial community pay particular attention to a company's ROE. The ROE can be calculated simply by dividing a firm's net income by the firm's shareholder's equity, and it can be subdivided into the key factors that drive the ROE. Investors and analysts focus on these drivers to develop a clearer picture of what is happening within a company. An analyst gathered the following data and calculated the various terms of the DuPont equation for three companies: ROE X 12.0% Profit Margin 57.3% 58.2% Total Assets Turnover 9.8 Equity Multiplier 2.14 Company A Company B Company C 10.2 15.5% 21.5% 2.61 3.60 58.0% 10.3 Referring to these data, which of the following conclusions will be true about the companies' ROES? The main driver of Company C's superior ROE, as compared with that of Company A's and Company B'S ROE, is its efficient use of assets. The main driver of Company C's superior ROE, as compared with that of Company A's and Company B's ROE, Is its greater use of debt financing The main driver of Company C's superior ROE, as compared with that of Company A's and Company B's ROE, is its operational efficiency. 10. Analyzing ratios One of the most important applications of ratio analysis is to compare a company's performance with that of other players in the industry or to compare its own performance over a period of time. Such analyses are referred to as a comparative analysis and trend analysis, respectively. A common size analysis requires the representation of financial statement data relative to a single financial statement item (or base account or value). What is the most commonly used base item for a common size balance sheet? Earnings before interest and taxes O Net income O Net sales Total assets Suppose you are conducting an analysis of the financial performance of Cute Camel Woodcraft Company over the past three years. The company did not issue new shares during these three years and has faced some operational difficulties. The company has thus pilot tested some new forecasting strategies for better operations management. You have collected the company's relevant financial data, made reasonable assumptions based on the information available, and calculated the following ratios. Year 3 Ratios Calculated Year 1 Year 2 6.60 4.62 13.20 10.56 0.50 0.40 Price-to-cash-flow Inventory turnover Debt-to-equity 3.70 8.45 0.32 Based on the preceding information, your calculations, and your assumptions, which of the following statements can be included in your analysis report? Check all that apply. A decline in the inventory turnover ratio can be explained by the new inventory management system that the company recently adopted, which led to more efficient inventory management A decline in the debt-to-equity ratio implies a decline in the creditworthiness of the firm. A plausible reason why Cute Camel Woodcraft Company's price-to-cash-flow ratio has decreased is that investors expect lower cash flow per share in the future. Cute Camel Woodcraft Company's ability to meet its debt obligations has improved since its debt-to-equity ratio decreased from 0.50 to 0.32