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, Madison, stepped into your office and asked the following MADISON: 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? MADISON: 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. Xavier, 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 Xavier 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 know about the DuPont analysis. Balance Sheet Data Income Statement Data Cash Accounts payable $1,800,000 Sales $30,000,000 $1,500,000 3,000,000 Accounts receivable Accruals 600,000 15,000,000 Cost of goods sold Gross profit Inventory 4,500,000 Notes payable 2,400,000 15,000,000 Current assets 9,000,000 Current liabilities 4,800,000 Operating expenses 7,500,000 7,500,000 Long-term debt 3,450,000 EBIT Total liabilities 8,250,000 Interest expense 702,000 Common stock EBT 1,687,500 5,062,500 6,798,000 2,379,300 Net fixed assets 6,000,000 Retained earnings Taxes Total equity 6,750,000 Net income $4,418,700 Total assets $15,000,000 Total debt and equity $15,000,000 If I remember correctly, the DuPont equation breaks down our return on equity (ROE) into three component ratios: the , the ratio, and 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 following table, select whether each of the ratios is correct or incorrect. Pavo Media Systems Inc.DuPont Analysis Ratios Value Correct/Incorrect Ratios Value Correct/Incorrect Profitability ratios Asset management ratio Gross profit margin (%) 50.00 Total assets turnover 2.00 22.66 Operating profit margin (%) Net profit margin (%) 29.46 Financial ratios Return on equity (%) 107.23 Equity multiplier 1.82 MADISON: 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: Note: Do not round intermediate calculations for this part. Numerator Calculation Denominator Value Pavo Media Systems Inc.DuPont Analysis Ratios Profitability Ratios Gross profit margin (%) Operating profit margin (%) Net profit margin (%) Return on equity (%) Asset management ratio Numerator Calculation Denominator Value Total assets turnover Financial ratios Numerator Calculation Denominator Value Equity multiplier MADISON: I see what I did wrong in my computations. Thanks for reviewing these calculations with me. You saved me from a lot of embarrassment! Xavier would have been very disappointed in me if I had him showed 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. 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. 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