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 general 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 if 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. Cash Accounts receivable Inventory Current assets Net fixed assets Total assets Balance Sheet Data $700,000 1,400,000 2,100,000 Notes payable $4,200,000 Current liabilities Long-term debt Total liabilities $840,000 280,000 1,120,000 $2,240,000 3,640,000 EBIT Common stock $5,880,000 980,000 2,940,000 $3,920,000 Retained earnings Total equity $9,800,000 Total debt and equity $9,800,000 Accounts payable Accruals 5,600,000 Income Statement Data Sales Cost of goods sold Gross profit Operating expenses Interest expense EBT Taxes Net income $14,000,000 7,000,000 $7,000,000 3,500,000 $3,500,000 571,200 $2,928,800 1,025,080 $1,903,720 If I remember correctly, the DuPont equation breaks down our ROE into three component ratios: 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 dropdown lists next to your values I'm going to select correct if your calculation is correct and incorrect if your calculation is incorrect. Ratios Profitability ratios Gross profit margin (%) Operating profit margin (4) Net profit margin (%) Return on equity (%) Value 50.00 20,92 1943 46.35 Hydra Cosmetics Inc. DuPont Analysis Correct/Incorrect Ratios Asset management ratio Total asset turnover Financial ratios Equity multiplier Value 1.43 1.67 the total asset turnover ratio, and the Correct/Incorrect LANDON: OK, it looks like I've got a couple of incorect 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. Round final answers to the nearest whole number. Profitability ratios Gross profit margin (%) Operating profit margin (%) Net profit margin (%) Return on equity (%) Asset management ratio Total asset turnover Financing ratios Equity multiplier Numerator Hydra Cosmetics Inc. DuPont Analysis Calculation Check all that apply. Denominator Value 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 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. Increase the firm's bottom-line profitability for the same volume of sales, which will increase the company's net profit margin. Decrease the company's use of debt capital because it will decrease the equity multiplier. LANDON: 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.