9. An analysis of company performance using DuPont analysis A sheaf of papers in his hand, your friend and colleague, Landon, steps into your office and asked the following. LANDON: 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? LANDON: 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. Amelia, 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 Amelia 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 Cash Accounts receivable Inventory Current assets $700,000 1,400,000 2,100,000 4,200,000 Accounts payable Accruals Notes payable Current liabilities Long-term debt Total liabilities Common stock Retained earnings Total equity Total debt and equity $840,000 280,000 1,120,000 2,240,000 3,640,000 5,880,000 980,000 2,940,000 3,920,000 $9,800,000 Income Statement Data Sales $14,000,000 Cost of goods sold 7,000,000 Gross profit 7,000,000 Operating expenses 3,500,000 EBIT 3,500,000 Interest expense 571,200 EBT 2,928,800 Taxes 732,200 Net income $2,196,600 Net fixed assets 5,600,000 Total assets $9,800,000 , the total asset If I remember correctly, the DuPont equation breaks down our ROE into three component ratios: the net profit margin turnover ratio, and the equity multiplier And, according to my understanding of the DuPont equation and its calculation of ROE, the three ratios provide insights into the company's management of its sales and share price , 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 to 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 Value Correct/Incorrect Ratios Asset management ratio Total assets turnover 1.43 Ratios Profitability ratios Gross profit margin (%) Operating profit margin (%) Net profit margin (%) Return on equity (%) 50.00 20.92 22.41 Financial ratios Equity multiplier 53.52 1.67 Hydra Cosmetics Inc. DuPont Analysis Ratios Calculation Value Numerator Denominator Profitability ratios Gross profit margin (%) Operating profit margin (%) Net profit margin (%) Return on equity (%) Asset management ratio Total assets turnover Financial ratios Equity multiplier LANDON: I see what I did wrong in my computations. Thanks for reviewing these calculations with me. You saved me from a lot of embarrassment! Amelia would have been very disappointed in me if I had showed her 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 cost and amount of assets necessary to generate each dollar of sales because it will increase the company's total assets turnover. Use more equity financing in its capital structure, which will increase the equity multiplier. 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 profit margin. 9. An analysis of company performance using DuPont analysis A sheaf of papers in his hand, your friend and colleague, Landon, steps into your office and asked the following. LANDON: 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? LANDON: 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. Amelia, 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 Amelia 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 Cash Accounts receivable Inventory Current assets $700,000 1,400,000 2,100,000 4,200,000 Accounts payable Accruals Notes payable Current liabilities Long-term debt Total liabilities Common stock Retained earnings Total equity Total debt and equity $840,000 280,000 1,120,000 2,240,000 3,640,000 5,880,000 980,000 2,940,000 3,920,000 $9,800,000 Income Statement Data Sales $14,000,000 Cost of goods sold 7,000,000 Gross profit 7,000,000 Operating expenses 3,500,000 EBIT 3,500,000 Interest expense 571,200 EBT 2,928,800 Taxes 732,200 Net income $2,196,600 Net fixed assets 5,600,000 Total assets $9,800,000 , the total asset If I remember correctly, the DuPont equation breaks down our ROE into three component ratios: the net profit margin turnover ratio, and the equity multiplier And, according to my understanding of the DuPont equation and its calculation of ROE, the three ratios provide insights into the company's management of its sales and share price , 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 to 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 Value Correct/Incorrect Ratios Asset management ratio Total assets turnover 1.43 Ratios Profitability ratios Gross profit margin (%) Operating profit margin (%) Net profit margin (%) Return on equity (%) 50.00 20.92 22.41 Financial ratios Equity multiplier 53.52 1.67 Hydra Cosmetics Inc. DuPont Analysis Ratios Calculation Value Numerator Denominator Profitability ratios Gross profit margin (%) Operating profit margin (%) Net profit margin (%) Return on equity (%) Asset management ratio Total assets turnover Financial ratios Equity multiplier LANDON: I see what I did wrong in my computations. Thanks for reviewing these calculations with me. You saved me from a lot of embarrassment! Amelia would have been very disappointed in me if I had showed her 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 cost and amount of assets necessary to generate each dollar of sales because it will increase the company's total assets turnover. Use more equity financing in its capital structure, which will increase the equity multiplier. 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 profit margin