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Walking down the hall of your office building with a sheat of papers in his hand, your friend and colleague, Jason, stepped into your office and asked the following. JASON: 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? JASON: 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. Anja, 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 Anja 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 Balance Sheet Data $500,000 Income Statement Data Sales 5600,000 $10,000,000 Accounts receivable Inventory Current assets 1,000,000 1,500,000 3,000,000 Accounts Hayable Accruals Notes payable Current liabilities Long-term debt Total liabilities Common stock Retained earnings Total equity Total debt and equity 200,000 800,000 1,600,000 2,050,000 4,550,000 612,500 1,837,500 2,450,000 $7,000,000 Cost of goods sold Gross Profit Operating expenses EBIT Interest expense 6,000,000 4,000,000 2,500,000 1,500,000 450,000 1,050,000 367.500 Net fixed assets 4,000,000 Takes Net income $682,500 Total assets $7,000,000 Inventory Current assets 1,500,000 3,000,000 Notes payable 800,000 Current liabilities 1,600,000 Long-term debt 2,950,000 Total liabilities 4,550,000 Common stock 612,500 Retained earnings 1,837,500 Total equity 2,450,000 Total debt and equity $7,000,000 Gross profit Operating expenses EBIT Interest expense EBT 4,000,000 2,500,000 1,500,000 450,000 1,050,000 367,500 $682,500 Net fixed assets 4,000,000 Taxes Net income Total assets $7,000,000 11 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. Value Correct/Incorrect In the following table, seiect whether each of the ratios is correct or incorrect. Pavo Media Systems Inc.DuPont Analysis Ratios Value Correct/Incorrect Profitability ratios Gross profit margin (9) 40.00 Operating profit margin (9) 10.50 Net profit margin (%) 9.75 Return on equity (9) 21.47 Ratios Asset management ratio Total assets turnover 1.43 Financial ratios Equity multiplier 2.54 JASON: 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 Denominator Pavo Media Systems Inc.DuPont Analysis Ratios Profitability Ratios Gross profit margin (%) Operating profit margin (%) Net profit margin (%) Return on equity (4) Calculation / Value > / Asset management ratio Total assets turnover Numerator Calculation Denominator Value Financial ratios Equity multiplier Numerator Calculation Denominator Value Financial ratios Equity multiplier Numerator Calculation Denominator Value JASON: I see what I did wrong in my computations. Thanks for reviewing these calculations with me. You saved me from a lot of embarrassment! Anja would have been very disappointed in me if I had her 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 ROEP Check all that apply. Increase the firm's bottom-line profitability for the same volume of sales, which 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 assets turnover Increase the cost and amount of assets necessary to generate each dollar of sales because it will increase the company's total assets turnover. Decrease the company's use of debt capital because it will decrease the equity multiplier. JASON: 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