Question

1. What differences would you expect to find between a convenience store and a car dealership, in terms of net profit margin and total asset turnover ratios? Why?

2. Do Problem E3-5 on textbook P.124. Below is a summary of the problem.

A firm has a net profit margin of 4.5%, total asset turnover of 0.72, and a financial leverage multiplier of 1.43. Calculate the firm’s ROA and ROE. What is the advantage to using the DuPont system to calculate ROE over the direct calculation of earnings available for common stockholders divided by common stock equity?

3. Do Problem P3-20 on textbook P. 133. You are given the following financial data for Pelican Paper Inc. and Timberland Forest Inc.

	Pelican Paper	Timberland
Total assets	$10,000,000	$10,000,000
Common stockholder equity	$ 9,000,000	$ 5,000,000
Total debt	$ 1,000,000	$ 5,000,000
Interest expense	$     100,000	$     500,000
Total Sales	$25,000,000	$25,000,000
EBIT	$   6,250,000	$ 6,250,000
Earnings available for common stockholders	$   3,690,000	$ 3,450,000

(1) Calculate each company’s (a) debt ratio and (b) times interest earned ratio. Discuss their financial risk and ability to cover the interest costs in relation to each other

(2) Calculate each company’s (a) net profit margin (b) return on assets, and (c) return on equity. Discuss their profitability relative to one another.

(3) In what way has the larger debt of Timberland Forest made it more profitable than Pelican Paper? What are the risks that Timberland’s investors undertake?

4. Use the financial data given in the above Question 3 for Pelican Paper Inc. and Timberland Forest Inc.

(1) Calculate each firm’s (a) total asset turnover (b) equity ratio (c) financial leverage multiplier

(2) Use Dupont system formula to calculate each firm’s ROA and ROE. Do you get the same answers of ROA and ROE as Question 3 (2)?

Answer 1

Answer 2.Calculation of Firm's ROE by using Dupont System:-

DuPont Analysis ROE=Net Profit Margin × AT × EM

where:

Net Profit Margin=Net Income​ / Sales (already given)

AT=Asset turnover

Asset Turnover= Sales / Total Assets(already given)

​EM=Equity multiplier

Equity Multiplier= Total Assets / Shareholders’ Equity(already given)

DuPont Analysis = 0.045*.072*1.43 = 0.046332 or 4.6332 %

Answer 3.1Calculate each company’s

(a) Debt ratio = Total Debts / Total assets

Pelican Papers Debt ratio = $1,000,000 / $10,000,000 = 0.10

Timberland Debt ratio = $5,000,000 / $10,000,000 = 0.50

(b) Times interest earned ratio = EBIT / Total Interest payables on total debts

  Pelican Papers Times interest earned ratio = $6,250,000 / $100,000 = 62.5 times

  Timberland Times interest earned ratio = $6,250,000 / $500,000 = 12.5 times

Answer 3.2 Calculate each company’s -

(a) Net Profit Margin=Net Income​ / Sales or Earnings avaliable for equity shareholders / Sales

Pelican Papers = $3,690,000 / $25,000,000 = 0.1476 or 14.76%

Timberland =$3,450,000 / $25,000,000 = .1380 or 13.80%

(b) Return on assets = Net Income or Earnings avaliable for equity shareholders / Total Assets

Pelican Papers =$3,690,000 / $10,000,000 = 3.69 %

Timberland =$3,450,000 / $10,000,000 = 3.45 %

(c) Return on equity (ROE) = Net Income or Earnings avaliable for equity shareholders / Shareholder's Equity

Pelican Papers = $3,690,000 / $9,000,000 = 41 %

Timberland =$3,450,000 / $5,000,000 = 69 %

Answer 3.3.1.Calculate each firm’s :-

(a) total asset turnover

(b) equity ratio or ROA

(c) financial leverage multiplier

Particulars	Pelican Paper	Timberland
Total assets	$10,000,000	$10,000,000
Common stockholder equity	$ 9,000,000	$ 5,000,000
Total debt	$ 1,000,000	$ 5,000,000
Interest expense	$     100,000	$     500,000
Total Sales	$25,000,000	$25,000,000
EBIT	$   6,250,000	$ 6,250,000
Earnings available for common stockholders	$   3,690,000	$ 3,450,000

(a) Total asset turnover

Asset Turnover Ratio = Sales / Total Assets

Pelican Papers = $25,000,000 / $10,000,000 = 2.5 times

Timberland = $25,000,000 / $10,000,000 = 2.5 times

(b) Equity ratio or ROA

Equity Ratio = Common Shareholder's equity / Total assets

Common Shareholder's equity = Total assets - total liabilities(already given in question)

Pelican Papers = $9,000,000 / $10,000,000 = .90, or 90%

Timberland =$5,000,000 / $10,000,000 = .50, or 50%

(c) Financial leverage multiplier

Financial leverage multiplier = Total Assets / Common Shareholder's equity

Pelican Papers = $10,000,000 / $9,000,000 = 1.11 times

Timberland =$10,000,000 / $5,000,000 = 2 times

(d) Net Profit Margin

Net Profit Margin=Net Income​ / Sales or Earnings avaliable for equity shareholders / Sales

Pelican Papers = $3,690,000 / $25,000,000 = 0.1476 or 14.76%

Timberland =$3,450,000 / $25,000,000 = .1380 or 13.80%

Answer 3.3.2.Using Dupont system formula to calculate each firm’s ROA and ROE :-

DuPont Analysis ROA= Operating profit margin * assets turnover ratio

where,

Operating profit margin = EBIT / Sales

Assets turnover ratio = Sales / Total Assets

Pelican Papers ROA :-

Operating profit margin = EBIT / Sales

Operating profit margin = $6,250,000 / $25,000,000 = 2.5 %

DuPont Analysis ROA= Operating profit margin * assets turnover ratio

DuPont Analysis ROA= 0.025 * 2.5 times = 0.0625 or 6.25%

Timberland ROA :-

Operating profit margin = EBIT / Sales

Operating profit margin = $6,250,000 / $25,000,000 = 2.5 %

DuPont Analysis ROA= Operating profit margin * assets turnover ratio

DuPont Analysis ROA= 0.025 * 2.5 times = 0.0625 or 6.25%

DuPont Analysis ROE=Net Profit Margin × AT × EM

where:

Net Profit Margin=Net Income​ / Sales (already calculated above)

AT=Asset turnover

Asset Turnover= Sales / Total Assets(already calculated above)

​EM=Equity multiplier

Equity Multiplier= Total Assets / Shareholders’ Equity(already calculated above)

Pelican Papers ROE :-

DuPont Analysis=Net Profit Margin × AT × EM

DuPont Analysis= .1476 * 2.5 times * 1.11 = .4099 or 41%

Timberland ROE :-

DuPont Analysis=Net Profit Margin × AT × EM

DuPont Analysis= .1380 * 2.5 times * 2 = .69 or 69%

Note :- Answers of ROA and ROE as Question 3 (2) ?

ROA of both companies are almost double if we calculate Dupoint formula.

ROE is same in both the cases wheater is calculated by using Dupoint formula or normally.