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9. An analysis of company performance using DuPont analysis Aa Aa walking down the hall of your office building with a sheaf of papers in his hand, your friend and colleague, Landon, stepped into your office and asked the following. Landon Do you have 10 or 15 minutes that you can spare? You Sure, I've got a meeting in an how can I help? start something new and then be interrupted by the meeting, so hour, but I dont want to 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 mmy numbers are correct? You Give me a minute to look at these financial statements and to remember what I know about the DuPont analysis. Balance sheet Data Income Statement Data Cash $500,000 Accounts payable $600,000 Sales $10,000,000 Accounts receivable Accruals 1,000,000 200,000 Cost of goods sold 5,000,000 Notes payable Inventory 1,500,000 Gross profit 800,000 s,000,000 Current assets Current liabilities 3,000,000 1,600,000 Operating expenses 2,500,000 Long-term debt 2,000,000 EBIT 2,500,000 Total liabilities 3,600,000 Interest expense 336,000 Common stock 600,000 EBT 2,164,000 Net fixed assets Retained earnings 3,000,000 1,800,000 es 757,400 Total equity Total debt and equity Net income 2,400,000 $1,406,600 Total assets $6,000,000 $6,000,000 If I remember correctly, the DuPont equation breaks down our ROE into three component ratios: the the total asset tumover 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. 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. Pavo Media Systems Inc. DuPont Analysis check if Check if Ratios Ratios Value Correct value Correct Profitability ratios Asset management ratio Gross profit margin (%) Operating profit margin (%) Net profit margin (%) Total asset tumover 50.00 1.67 21.64 Financing ratios 23.44 Return on equity (%) Equity multiplier 65.37 1.67 Landon OK, it looks like I've got a couple of inoorrect 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: Pavo Media Systems Inc DuPont Analysis Ratios Value Calculation Profitability ratios Denominator Numerator Gross profit margin (%) Operating profit margin (%) / / Net profit margin (%) Return on equity (%) C ASset management ratio Total asset turnover Financing ratios Equity multiplier andon I see what I did wrong in my computations. Thanks for reviewing these calculations with me. You saved me from a lot of embarrassmentt 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 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.) 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 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. andon 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. IlII