Question

A firm has been experiencing low profitability in recent years. Perform an analysis of the firm's financial position using the DuPont equation. The firm has no lease payments, but has a $1 million sinking fund payment on its debt. The most recent industry average ratios and the firm's financial statements are as follows:

	Industry Average Ratios
Current ratio	3.55x		Fixed assets turnover	6.67x
Debt/total assets	29.12%		Total assets turnover	3.00x
Times interest earned	27.07x		Profit margin	8.98%
EBITDA coverage	31.70x		Return on total assets	26.95%
Inventory turnover	12.34x		Return on common equity	38.02%
Days sales outstandinga	45 days		Return on invested capital	11.50%

^aCalculation is based on a 365-day year.

Balance Sheet as of December 31, 2014 (Millions of Dollars)
Cash and equivalents	$46		Accounts payable	$29
Accounts receivables	48		Other current liabilities	20
Inventories	97		Notes payable	23
Total current assets	$191		Total current liabilities	$72
			Long-term debt	11
			Total liabilities	$83
Gross fixed assets	157		Common stock	77
Less depreciation	63		Retained earnings	125
Net fixed assets	$94		Total stockholders' equity	$202
Total assets	$285		Total liabilities and equity	$285

Income Statement for Year Ended December 31, 2014 (Millions of Dollars)
Net sales	$570.0
Cost of goods sold	376.2
Gross profit	$193.8
Selling expenses	57.0
EBITDA	$136.8
Depreciation expense	5.7
Earnings before interest and taxes (EBIT)	$131.1
Interest expense	3.1
Earnings before taxes (EBT)	$128.0
Taxes (40%)	51.2
Net income	$76.8

Calculate those ratios that you think would be useful in this analysis. Do not round intermediate steps. Round your answers to two decimal places.

	Firm	Industry Average
Current ratio	x	3.55x
Debt to total capital	%	29.12%
Times interest earned	x	27.07x
EBITDA coverage	x	31.70x
Inventory turnover	x	12.34x
DSO	days	45days
F.A. turnover	x	6.67x
T.A. turnover	x	3.00x
Profit margin	%	8.98%
Return on total assets	%	26.95%
Return on common equity	%	38.02%
Return on invested capital	%	11.50%

Construct aa Du Pont equation, and compare the company's ratios to the industry average ratios. Do not round intermediate steps. Round your answers to two decimal places.

	Firm	Industry
Profit margin	%	8.98%
Total assets turnover	x	3.00x
Equity multiplier

Do the balance sheet accounts or the income statement figures seem to be primarily responsible for the low profits?
-Select-IIIIIIIVVItem 17

Analysis of the extended Du Pont equation and the set of ratios shows that the turnover ratio of sales to assets is quite low. Either sales should be higher given the present level of assets, or the firm is carrying more assets than it needs to support its sales.

Analysis of the extended Du Pont equation and the set of ratios shows that the turnover ratio of sales to assets is quite low. Either sales should be lower given the present level of assets, or the firm is carrying less assets than it needs to support its sales.

Analysis of the extended Du Pont equation and the set of ratios shows that most of the Asset Management ratios are below the averages. Either assets should be higher given the present level of sales, or the firm is carrying less assets than it needs to support its sales.

The low ROE for the firm is due to the fact that the firm is utilizing more debt than the average firm in the industry and the low ROA is mainly a result of an excess investment in assets.

The low ROE for the firm is due to the fact that the firm is utilizing less debt than the average firm in the industry and the low ROA is mainly a result of an lower than average investment in assets.

Which specific accounts seem to be most out of line relative to other firms in the industry?
-Select-IIIIIIIVVItem 18

The accounts which seem to be most out of line include the following ratios: Inventory Turnover, Days Sales Outstanding, Total Asset Turnover, Return on Assets, and Return on Equity.

The accounts which seem to be most out of line include the following ratios: Current, EBITDA Coverage, Inventory Turnover, Days Sales Outstanding, and Return on Equity.

The accounts which seem to be most out of line include the following ratios: Debt to Total Assets, Inventory Turnover, Total Asset Turnover, Return on Assets, and Profit Margin.

The accounts which seem to be most out of line include the following ratios: Times Interest Earned, Total Asset Turnover, Profit Margin, Return on Assets, and Return on Equity.

The accounts which seem to be most out of line include the following ratios: Inventory Turnover, Days Sales Outstanding, Fixed Asset Turnover, Profit Margin, and Return on Equity.

If the firm had a pronounced seasonal sales pattern, or if it grew rapidly during the year, how might that affect the validity of your ratio analysis?
-Select-IIIIIIIVVItem 19

If the firm had seasonal sales patterns, or if it grew rapidly during the year, many ratios would most likely be distorted.

It is more important to adjust the debt ratio than the inventory turnover ratio to account for any seasonal fluctuations.

Seasonal sales patterns would most likely affect the profitability ratios, with little effect on asset management ratios. Rapid growth would not substantially affect your analysis.

Rapid growth would most likely affect the coverage ratios, with little effect on asset management ratios. Seasonal sales patterns would not substantially affect your analysis.

Seasonal sales patterns would most likely affect the liquidity ratios, with little effect on asset management ratios. Rapid growth would not substantially affect your analysis.

How might you correct for such potential Problems?
-Select-IIIIIIIVVItem 20

It is possible to correct for such Problems by using average rather than end-of-period financial statement information.

It is possible to correct for such Problems by comparing the calculated ratios to the ratios of firms in a different line of business.

It is possible to correct for such Problems by comparing the calculated ratios to the ratios of firms in the same industry group over an extended period.

There is no need to correct for these potential Problems since you are comparing the calculated ratios to the ratios of firms in the same industry group.

It is possible to correct for such Problems by insuring that all firms in the same industry group are using the same accounting techniques.

Answer 1

a)
Calculate the following ratios. Do not round intermediate steps. Round your answers to two decimal places.
	Firm		Industry Average
Current ratio = Current Assets/ Current Liabilities = $191/$72	2.65	X	3.55x
Debt to total capital = Total liabilities/ Total liabilities & shareholders equity = $83/$285	29.12%		29.12%
Times interest earned = EBIT/ Interest = $131.1/$3.1	42.29	X	27.07x
EBITDA coverage = EBITDA + Lease Payments/(Interest + Lease Pay. + Principal Pay,) = $136.8/$3.1 + $1	33.37	X	31.70x
Inventory turnover = Sales/ Inventories = $570/$97	5.88	X	12.34x
Days sales outstanding = Account Receivables / (Sales /365) = 48/(570/365)	30.74	Days	45 days
Fixed assets turnover = Sales/Total Fixed Assets = $570/$94	6.06	X	6.67x
Total assets turnover = Sales/ Total Assets = $570/$285	2.00	X	3.00x
Profit margin = Net Profit/ Sales = $76.8/$570	13.47%		8.98%
Return on total assets = Net Profit/Total Assets = $76.8 / $285	26.95%		26.95%
Return on common equity = Net profit/ Total shareholder's equity = $76.8/$202	38.02%		38.02%
Return on invested capital = EBIT x (1 – tax rate)/ Long term Debt + Total shareholder equity = ($131.1 x (1 - 40%))/($11+$202)	36.93%		11.50%
b)
Construct a DuPont equation for the firm and the industry. Do not round intermediate steps. Round your answers to two decimal places.
	Firm		Industry
Profit margin	13.47%		8.98%
Total assets turnover	2.00	X	3.00x
Equity multiplier = ROE/ROA	1.41	X	1.41
ROE = Profit Margin x Total Asset Turnover x Equity Multiplier	38.02%		38.02%
c)
Do the balance sheet accounts or the income statement figures seem to be primarily responsible for the low profits?
Analysis of the extended Du Pont equation and the set of ratios shows that the turnover ratio of sales to assets is quite low. Either sales should be higher given the present level of assets, or the firm is carrying more assets than it needs to support its sales.
e) If the firm had a pronounced seasonal sales pattern, or if it grew rapidly during the year, how might that affect the validity of your ratio analysis?
If the firm had seasonal sales patterns, or if it grew rapidly during the year, many ratios would most likely be distorted.
f)How might you correct for such potential Problems?
It is possible to correct for such Problems by using average rather than end-of-period financial statement information.