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9. An analysis of company performance using DuPont analysis A sheaf of papers in his hand, your friend and colleague, Jason, steps 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 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 whether 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. Balance Sheet Data Income Statement Data Cash $1,000,000 Accounts payable $1,200,000 Sales $20,000,000 Accounts receivable 2,000,000 Accruals 400,000 Cost of goods sold 10,000,000 Inventory 3,000,000 Notes payable 1,600,000 Gross profit 10,000,000 Current assets 6,000,000 Current liabilities 3,200,000 Operating expenses 5,000,000 Long-term debt 2,300,000 EBIT 5,000,000 Total liabilities 5,500,000 Interest expense 468,000 Common stock 1,125,000 EBT 4,532,000 Net fixed assets 4,000,000 Retained earnings 3,375,000 Taxes 1,133,000 Total equity 4,500,000 Net income $3,399,000 Total assets $10,000,000 Total debt and equity $10,000,000 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, 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. Cepeus Manufacturing Inc. DuPont Analysis Ratios Value Correct/Incorrect Ratios Value Correct/Incorrect Profitability ratios Asset management ratio Gross profit margin (%) 50.00    Total assets turnover 2.00    Operating profit margin (%) 22.66    Net profit margin (%) 33.99    Financial ratios Return on equity (%) 123.72    Equity multiplier 1.82    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: Do not round intermediate calculations and round your final answers up to two decimals. Cepeus Manufacturing Inc. DuPont Analysis Ratios Calculation Value Profitability ratios Numerator Denominator Gross profit margin (%) / = Operating profit margin (%) / = Net profit margin (%) / = Return on equity (%) / = Asset management ratio Total assets turnover / = Financial ratios Equity multiplier / = 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 showed her my original work. So, now let’s switch topics and identify general strategies that could be used to positively affect Cepeus’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. 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 efficiency of its assets so that it generates more sales with each dollar of asset investment and increases the company’s total assets turnover. Use more equity financing in its capital structure, which will increase 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. Grade It Now Save & Continue Continue without saving

Answer 1

RATIOS	VALUE	CORRECT/INCORRECT	RATIOS	VALUE	CORRECT/INCORRECT
Profitability Ratios			Asset Management Ratio
Gross Profit Margin(%)	50.00	CORRECT	Total Assets Turnover	2.00	CORRECT
Operating Profit Margin(%)	22.66
Net Profit Margin(%)	33.99		Financial Ratios
Return On Equity (%)	123.72		Equity Multiplier	1.82

RATIOS	CALCULATION			VALUE
Profitability ratios	Numerator		Denominator
Gross Profit Margin(%)	Gross Profit $10,000,000	/	Sales $20,000,000	=	50.00
Operating Profit Margin (%)	EBIT $5,000,000	/	Sales $20,000,000	=	25.00
Net Profit Margin(%)	Net Income $ 3,399,000	/	Sales $20,000,000	=	16.99
Return on equity (%)	Net Income $3,399,000	/	Total Equity $10,000,000	=	75.53
Asset Management ratio
Total Assets Turnover	Sales $20,000,000	/	Total assets $ 10,000,000	=	2.00
Financial ratios
Equity Multiplier	Total Assets $10,000,000	/	Total equity $ 4,500,000	=	2.22

DUPont Analysis

ROE = NET PROFIT MARGIN * TOTAL ASSET TURNOVER * EQUITY MULTIPLIER

ROE = 16.99 * 2.00 * 2.22 = 75.43%