9. An analysis of company performance using DuPont analysis 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. Cash Accounts receivable Balance Sheet Data $700,000 1,400,000 2,100,000 4,200,000 Accounts payable Accruals Inventory Notes payable Current liabilities $840,000 280,000 1,120,000 2,240,000 4,130,000 6,370,000 Income Statement Data Sales Cost of goods sold Gross profit Operating expenses EBIT Interest expense $14,000,000 8,400,000 5,600,000 3,500,000 2,100,000 630,000 Current assets EBT 1,470,000 Long-term debt Total liabilities Common stock Retained earnings Total equity Total debt and equity Net fixed assets 5,600,000 514,500 857,500 2,572,500 3,430,000 $9,800,000 Taxes Net income $955,500 Total assets $9,800,000 If I remember correctly, the DuPont equation breaks down our return on equity (ROE) into three component ratios: the ratio, and the 2, 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. In the table below, select whether each of the ratios is correct or incorrect. Hydra Cosmetics Inc.DuPont Analysis Ratios Value Correct/Incorrect Ratios Value Correct/Incorrect Profitability ratios Asset management ratio Gross profit margin (%) Total asset turnover 40.00 10.50 1.43 - Operating profit margin (%) Net profit margin (%) Return on equity (%) 9.75 Financing ratios Equity multiplier 21.47 1.54 - 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: Pro Note: Do not round intermediate calculations for this part. Hydra Cosmetics Inc.DuPont Analysis Calculation Ratios Value Numerator Denominator Profitability ratios Gross profit margin (%) Operating profit margin (%) Net profit margin (%) Return on equity (%) 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 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. 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. 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. O Increase the firm's bottom-line profitability for the same volume of sales, which will increase the company's net profit margin. 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. 9. An analysis of company performance using DuPont analysis 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. Cash Accounts receivable Balance Sheet Data $700,000 1,400,000 2,100,000 4,200,000 Accounts payable Accruals Inventory Notes payable Current liabilities $840,000 280,000 1,120,000 2,240,000 4,130,000 6,370,000 Income Statement Data Sales Cost of goods sold Gross profit Operating expenses EBIT Interest expense $14,000,000 8,400,000 5,600,000 3,500,000 2,100,000 630,000 Current assets EBT 1,470,000 Long-term debt Total liabilities Common stock Retained earnings Total equity Total debt and equity Net fixed assets 5,600,000 514,500 857,500 2,572,500 3,430,000 $9,800,000 Taxes Net income $955,500 Total assets $9,800,000 If I remember correctly, the DuPont equation breaks down our return on equity (ROE) into three component ratios: the ratio, and the 2, 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. In the table below, select whether each of the ratios is correct or incorrect. Hydra Cosmetics Inc.DuPont Analysis Ratios Value Correct/Incorrect Ratios Value Correct/Incorrect Profitability ratios Asset management ratio Gross profit margin (%) Total asset turnover 40.00 10.50 1.43 - Operating profit margin (%) Net profit margin (%) Return on equity (%) 9.75 Financing ratios Equity multiplier 21.47 1.54 - 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: Pro Note: Do not round intermediate calculations for this part. Hydra Cosmetics Inc.DuPont Analysis Calculation Ratios Value Numerator Denominator Profitability ratios Gross profit margin (%) Operating profit margin (%) Net profit margin (%) Return on equity (%) 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 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. 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. 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. O Increase the firm's bottom-line profitability for the same volume of sales, which will increase the company's net profit margin. 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