9. An analysis of company performance using DuPont analysis Aa Aa Walking down the hall of your office building with a sheaf of papers in her hand, your friend and colleague, Ashley, stepped into your office and asked the following Ashley: 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? Ashley: 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. Mikel, 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 if I've missed anything. Here are the balance sheet and income statement data that Mikel 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 $700,000 Accounts payable 1,400,000 Accruals Income Statement Data Cash 840,000 Sales 280,000 Cost of goods sold $14,000,000 7,000,000 Accounts receivable Balance Sheet Data $700,000 Accounts payable 1,400,000 Accruals 2,100,000 Notes payable 4,200,000 Income Statement Data $14,000,000 7,000,000 7,000,000 3,500,000 3,500,000 470,400 3,029,600 1,060,360 $1,969,240 Cash Accounts receivable Inventory $840,000 Sales 280,000 Cost of goods sold 1,120,000 Gross profit 2,240,000 Operating expenses 2,800,000 EBIT 5,040,000 Interest expense Current assets Current liabilities Long-term debt Total liabilities 840,000 EBT 2,520,000 Taxes 3,360,000 Net income Common stock Net fixed assets 4,200,000 Retained earnings Total equity Total assets $8,400,000 Total debt and equity $8,400,000 If I remember correctly, the DuPont equation breaks down our return on equity (ROE) into three component ratios: the net profit margin , the total asset 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 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 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 leaveit unchecked if your calculation is incorrect. Cepeus Manufacturing Inc. DuPont Analysis Check if Correct Check itf Correct Value Value Ratios Profitability ratios Gross profit margin (%) Operating profit margin (%) Net profit margin(%) Return on equity (%) Ratios Asset management ratio 50.00 21.64 23.44 65.37 Total asset turnover 1.67 Financing ratios Equity multiplier 1.67 Ashley: 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 Cepeus Manufacturing Inc. DuPont Analysis Cepeus Manufacturing Inc. DuPont Analysis Ratios Calculation Value Profitability ratios Numerator Denominator Gross profit margin (%) Operating profit margin (%) Net profit margin (%) Return on equity (%) 7,000,00014,000,000 3,500,00014,000,000 Asset management ratio Total asset turnover Financing ratios Equity multiplier Ashley: I see what I did wrong in my computations. Thanks for reviewing these calculations with me. You saved me from a lot of embarrassment! Mikel would have been very disappointed in me if I had himshowed my original work So, now let's switch topics and identify general strategies that could be used to positively affect Cepeus's ROE. OK, so given your knowledge of the component ratios used in the DuPont equation, which of the following strategies You: should improve the company's ROE? (Check all that apply.) Total asset turnover Financing ratios Equity multiplier Ashley: I see what I did wrong in my computations. Thanks for reviewing these calculations with me. You saved me from a lot of embarrassment! Mikel would have been very disappointed in me if I had himshowed my original work. So, now let's switch topics and identify general strategies that could be used to positively affect Cepeus's ROE OK, so given your knowledge of the component ratios used in the DuPont equation, You: which of the following strategies should improve the company's ROE? (Check all that apply.) 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 cost and amount of assets necessary to generate each dollar of sales because it will increase the company's total asset 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 asset turnover Ashley 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