Question

Golden cup case study

You were provided with the following balance sheet for Golden Cup firm for the year ended Dec 31^st, 2018.

Consolidated Balance sheet Golden Cup. As of Dec 31st, 2018
Assets		Liabilities + Owners Equity
Current Assets		Current Liabilities
Cash	40,000	Accounts Payable	12,000
Accounts Receivables	4,000	Notes Payable	6,000
Inventory	14,000	Accrue Wages	1000
Total Current Assets	58,000	Total Current Liabilities	19,000
Fixed Assets		Long term debt	40,000
Property, Plant, and Equipment	56,000	Owners’ equity
Goodwill	24,000	Common Shares	40,000
Total Fixed Assets	80,000	Retained Earnings	39,000
		Total Owners equity	79,000
Total Assets	138,000	Liabilities + O.E	138,000

In addition to that, you know the following facts about firm’s operations throughout the year:

• Golden Cup revenues for the year includes the following: Domestic revenues $160,000. International revenues $80,000. Out of Golden Cup’s sales, cost of sales and direct labor is 50% of annual revenues.

• Because of the strong competition that it faces, Golden Cup has a generous marketing plan. Golden Cup signed a contract with the marketing planet Inc. by which the marketing agency will be responsible for Golden Cup marketing for five years period started this year. The contract costs Golden Cup $100,000 that were paid up front, however the company thinks this plan will affect its sales evenly over the five years period. Golden Cup also spends $30,000 in the form of general and administrative expenses per year. Golden Cup depreciable assets historical value is $40,000 and is depreciated on a straight line basis over 10 years.

• Golden Cup pays interest rate of 10% on its Long-term debt outstanding.

• Out of the year’s net income, Golden Cup is planning to repay $30,000 to its shareholders in the form of cash dividends. The company currently has 60,000 shares outstanding

income statement for Golden Cup:

Consolidated Income Statement Golden Cup. As of Dec 31st, 2018
	Show your workings here	Final answer here in $
Revenues	160000+80000	240,000
(-) Cost of goods sold	50% of 240,000	(120,000)
Gross margin	Revenue – CGS	120,000
(-) Marketing expenses	100,000/5	(20,000)
(-) General and administrative expenses	Given	(30,000)
(-) Depreciation	40,000/10 Years	(4,000)
EBIT	GM- Marketing Expenses – General and Admin Expenses- Depreciation	66,000
(-) Interest expenses	40,000* 10%	(4,000)
EBT	EBIT – Interest	62,000
(-) Tax expenses	Tax Rate – 21%, EBT* (0.21)	(13,020)
Net income	EBT- Tax Expenses	48,980
Dividends	Given	30,000
Additions to Retained Earnings	Net income- Dividends	18,980

6- If you are given the following information about the year ended 2017 (previous year).

Total assets = $120,000,   Total Equity = $70,000,   Sales = 150,000,   Net income = $35,000                      

a- Calculate Golden Cup’s profitability for year ended 2017.

b- Calculate Golden Cup’s profitability for year ended 2018.

c- Based on your knowledge of determinants of corporate profitability (DuPont identity), did any significant change happen to Golden Cup’s profitability? Did it increase or decrease? What is the underlying reason behind the change, if any?

Answer 1

Golden Cup's profitability for the years ended 2017 & 2018
	a)	b)
	2017	2018
Net Income	35000	48980
Sales	150000	240000
Total Assets	120000	138000
Total equity	70000	79000
Net Income Margin
(net income/ total sales)*100	23%	20%
Assets Turnover	1.25	1.74
(Sales/ Assets)
Financial leverage	1.71	1.75
(assets/equity)

After analysing above indicators, we can find out that company's profit margin is decreased by 3% but operating efficiency is improved as assets turnover is substantially increased. The financial leverage is more or less constant.

C)

Golden Cup's profitability for the years ended 2017 & 2018
	a)	b)
	2017	2018
Net Income	35000	48980
Sales	150000	240000
Total Assets	120000	138000
Total equity	70000	79000
Earnings Before Taxes	44303.8	62000
EBIT	48303.8	66000
Net Income Margin
(net income/ total sales)*100	23%	20%
Assets Turnover	1.25	1.74
(Sales/ Assets)
Financial leverage	1.71	1.75
(assets/equity)
EBT Margin
(net income/ total sales)*100	30%	26%
EBIT Margin
(net income/ total sales)*100	32%	28%

Let we use Dupont identity against this information.

Dupont Formula:

ROE = Net Income Margin * Assets Turnover * Financial Leverage

	2017	2018
ROE	50%	62%

Return on equity is improved over the previous year. What might be the reason. It could be the result of improvement in efficiency which might have been led to more sales increasing the return. But these analysis are not isolating operating and financial costs.

Let we use Five point formula of Dupont analysis to go nto further analysis by removing Tax effect:

ROE = EBT Margin * Assets Turnover * Financial Leverage * (1-TR)

where TR = Tax Rate

	2017	2018
ROE	50%	62%

Let we use Six point formula of Dupont analysis to go nto further analysis by finding both Tax and Interest burden:

ROE = (EBT Margin * Assets Turnover-IER) * Financial Leverage * (1-TR)

where IER = Interest Expense Rate

	2017	2018
ROE	50%	62%

It means overall improvement in net assets usage has improved the performance but increase in costs has brought down the profit margin.