Problem
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 can I help? CHLOE: I've been reviewing the company's financial statements and looking for ways to improve our performance, in general, 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 whether 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. Co 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. 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: Do not round intermediate calculations and round your final answers up to two decimals. Hydra Cosmetics Inc. DuPont Analysis \begin{tabular}{lllllll} Balance Sheet Data & & & & \multicolumn{2}{l}{ Income Statement Data } \\ \hline Cash & $600,000 & Accounts payable & $720,000 & Sales & $12,000,000 \\ Accounts receivable & 1,200,000 & Accruals & 240,000 & Cost of goods sold & 7,200,000 \\ \hline Inventory & 1,800,000 & Notes payable & 960,000 & Gross profit & 4,800,000 \\ \hline Current assets & 3,600,000 & Current liabilities & 1,920,000 & Operating expenses & 3,000,000 \\ & & Long-term debt & 2,400,000 & EBIT & 1,800,000 \\ & & Total liabilities & 4,320,000 & Interest expense & 403,200 \\ \hline Net fixed assets & 3,600,000 & Retained earnings & 2,160,000 & Taxes & 1,396,800 \\ & & Total equity & 2,880,000 & Net income & 349,200 \\ \hline Total assets & $7,200,000 & Total debt and equity & $7,200,000 & & \\ \hline \end{tabular} 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 showed him 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? eck 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. Increase the interest rate on its notes payable or long-term debt obligations because it will reduce the company's net profit margin. Reduce the company's operating expenses, its cost of goods sold, and/or the interest rate on its borrowed funds because this will incre the company's net profit margin. Use more debt financing in its capital structure and increase the equity multiplier. 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. If I remember correctly, the DuPont equation breaks down our ROE into three component ratios: the , the total asset turnover 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, anc 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. Hydra Cosmetics Inc. DuPont Analysis
