9. An analysis of company performance using DuPont analysis A sheaf of papers in her hand, your friend and colleague, Chloe, steps 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 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 conclusions by you to see whether I've missed anything Here are the balance sheet and income statement data that Enic 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 Accounts payable Accruals Cash $1,000,000 Accounts receivable 2,000,000 Inventory 3,000,000 Current assets 6,000,000 Notes payable Current liabilities Long-term debt Total liabilities Common stock Retained earnings Total equity Total debt and equity $1,200,000 400,000 1,600,000 3,200,000 4,500,000 7,700,000 1,575,000 4,725,000 6,300,000 514,000,000 Sales $20,000,000 Cost of goods sold 12,000,000 Gross profit 8,000,000 Operating expenses 5,000,000 EBIT 3,000,000 Interest expense 732,000 EBT 2,268,000 Taxes 567,000 Net fixed assets 8,000,000 Net income $1,701,000 Total assets $14,000,000 I remember correctly, the DuPont equation breaks down our ROE into three component ratios: the net profit margin turnover ratio, and the equity multiplier the total asset And, according to my understanding of the DuPont equation and its calculation of ROE, the three ratios provide insights into the company's use of debt versus equity financing effectiveness in using the company's assets, and control over its expenses 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 the side of your calculated value if your calculation is correct and leave it unchecked if your calculation is incorrect. Hydra Cosmetics Inc. DuPont Analysis Value Correct/Incorrect Ratios Value Correct/Incorrect 40.00 Ratios Profitability ratios Gross profit margin (9) Operating profit margin (%) Net profit margin (%) Return on equity (%) Asset management ratio Total assets turnover Correct 1.43 Correct 11.34 Incorrect 12.15 Incorrect 31.62 Incorrect Financial ratios Equity multiplier 1.82 Incorrect 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: IVe just made rough calculations, so let me complete this table by inputting the components of each ratio and its value: Hydra Cosmetics Inc. DuPont Analysis Calculation Value Numerator 8,000,000 Denominator 20,000,000 - - Ratios Profitability ratios Gross profit margin (%) Operating profit margin (%) Net profit margin (%) Return on equity (%) Asset management ratio Total assets turnover Financial 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 embarrassmenti 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 Decrease the company's use of debt capital because it will decrease the equity multiplier. Increase the cost and amount of assets necessary to generate each door of sales because it will increase the company's total assets turnover 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 Reduce the company's operating expenses, its cost of goods sold, and/or the interest rate on its borrowed funds because this will increase the company's net proht margin