9. An analysis of company performance using DuPont analysis Aa Aa E Walking down the hall of your office building with a sheaf 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 conclusions 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. Cash Accounts receivable Inventory Current assets Balance Sheet Data $1,500,000 Accounts payable 3,000,000 Accruals 4,500,000 Notes payable 9,000,000 Current liabilities Long-term debt Total liabilities Common stock 9,000,000 Retained earnings Total equity $18,000,000 Total debt and equity $1,800,000 600,000 2,400,000 4,800,000 6,000,000 10,800,000 1,800,000 5,400,000 7,200,000 $18,000,000 Income Statement Data Sales $30,000,000 Cost of goods sold 15,000,000 Gross profit 15,000,000 Operating expenses 7,500,000 EBIT 7,500,000 Interest expense 1,008,000 EBT 6,492,000 Taxes 2,272,200 Net income $4,219,800 oc Net fixed assets Total assets If I remember correctly, the DuPont equation breaks down our return on equity (ROE) into three component ratios: the , the ratio, and the If I remember correctly, the DuPont equation breaks down our return on equity (ROE) into three component ratios: the ratio, and the , 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. 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. Pavo Media Systems Inc. DuPont Analysis Check if Correct Ratios Asset management ratio Total asset turnover Check if Correct Value Value 1.67 D Ratios Profitability ratios Gross profit margin (%) Operating profit margin (%) Net profit margin (%) Return on equity (%) 50.00 21.64 23.44 65.37 Financing ratios Equity multiplier 1.67 0. 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: Pavo Media Systems Inc. DuPont Analysis Calculation Numerator Denominator Value Ratios Profitability ratios Gross profit margin (%) Operating profit margin (%) Net profit margin (%) 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: Pavo Media Systems Inc. DuPont Analysis Calculation Numerator Denominator Value Ratios 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 himshowed my original work. So, now let's switch topics and identify general strategies that could be used to positively affect Pavo'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.) O Decrease the amount of debt financing used by the company, which will decrease the total asset turnover ratio. Increase the interest rate on its notes payable or long-term debt obligations because it will reduce the company's net profit margin. Use more debt financing in its capital structure and 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. 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