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 $$800,000$ Accounts payable $$960,000$ Sales $$16,000,000$

Accounts receivable $1,600,000$ Accruals $320,000$ Cost of goods sold $8,000,000$

Inventory $2,400,000$ Notes payable $1,280,000$ Gross profit $8,000,000$

Current assets $4,800,000$ Current liabilities $2,560,000$ Operating expenses $4,000,000$

Long$-$term debt $5,280,000$ EBIT $4,000,000$

Total liabilities $7,840,000$ Interest expense $787,200$

Common stock $840,000$ EBT $3,212,800$

Net fixed assets $6,400,000$ Retained earnings $2,520,000$ Taxes $1,124,480$

Total equity $3,360,000$ Net income $$2,088,320$

Total assets $$11,200,000$ Total debt and equity $$11,200,000$

If I remember correctly, the DuPont equation breaks down our return on equity $($ROE$)$ into three component ratios: the net profit margin $,$ the total assets turnover ratio, and the equity multiplier $.$

And, according to my understanding of the DuPont equation and its calculation of ROE, the three ratios provide insights into the company$$s use of debt versus equity financing $,$ effectiveness in using the company$$s assets, and management of its liquidity and its tax records $.$

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.

Hydra Cosmetics Inc.DuPont Analysis

Ratios Value Correct$/$Incorrect Ratios Value Correct$/$Incorrect

Profitability ratios Asset management ratio

Gross profit margin $(\%)50\mathrm{.}00$ Correct Total assets turnover $1\mathrm{.}43$ Correct

Operating profit margin $(\%)20\mathrm{.}08$ Correct

Net profit margin $(\%)18\mathrm{.}65$ Correct Financial ratios

Return on equity $(\%)38\mathrm{.}14$ Correct Equity multiplier $1\mathrm{.}43$ Correct

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:

Note: Do not round intermediate calculations for this part.

Hydra Cosmetics Inc.DuPont Analysis

Calculation

Ratios

Numerator

Denominator

Value

Profitability Ratios

Gross profit margin $(\%)8,000,000/11,200,000=50\mathrm{.}00$

Operating profit margin $(\%)/=25\mathrm{.}00$

Net profit margin $(\%)/16,000,000=13\mathrm{.}05$

Return on equity $(\%)/3,360,000=3\mathrm{.}33$

Calculation

Value

Numerator

Denominator

Asset management ratio

Total assets turnover $/=$

Financial ratios

Calculation

Value

Numerator

Denominator

Equity multiplier $/=$

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 him showed 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?

Check all that apply.

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.

Decrease the company$$s use of debt capital because it will decrease the equity multiplier.

Use more debt financing in its capital structure and increase the equity multiplier.

Increase the cost and amount of assets necessary to generate each dollar of sales because it will increase the company$$s total assets turnover.

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.

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