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 2x Fixed assets turnover 5x

debt-to-capital ratio 18% Total assets turnover 3x

Times interest earned 5x Profit margin 4.25%

EBITDA coverage 8x Return on total assets 12.75%

Inventory turnover 10x Return on common equity 17.50%

Days sales outstanding (*) 30 days Return on invested capital 15.40%

*calculation is based on a 365 day year

Balance Sheet as of December 31, 2019 (Millions of Dollars)

Cash and equivalents	$80	Accounts Payable	$50
Accounts receivables	85	Other current liabilities	$10
Inventories	155	Notes payable	55
Total current assets	320	Total current liabilities	115
Gross fixed assets	265	Long-term debt	25
Less depreciation	85	Total liabilities	140
Net fixed assets	180	Common stock	125
Total assets	500	Retained earnings	235
		Total stockholders' equity	360
		Total liabilities and equity	500

Income Statement for Year Ended Dec, 31, 2019 (Millions of Dollars)

Net sales $805.00

Cost of goods sold 640.00

Gross profit $165.00

Selling expenses 88.50

EBITDA $76.50

Depreciation expense 16.00

Earnings before interest and taxes (EBIT) $60.50

Interest expense 7.50  

Earnings before taxes (EBT) $53.00

Taxes (25%)13.25

Net income$39.75

Firm	Industry Average
Current ratio	×	2	×
Debt to total capital	%	18	%
Times interest earned	×	5	×
EBITDA coverage	×	8	×
Inventory turnover	×	10	×
Days sales outstanding	days	30	days
Fixed assets turnover	×	5	×
Total assets turnover	×	3	×
Profit margin	%	4.25	%
Return on total assets	%	12.75	%
Return on common equity	%	17.50	%
Return on invested capital	%	15.40	%

Construct a DuPont equation for the firm and the industry. Do not round intermediate calculations. Round your answers to two decimal places.

Firm	Industry
Profit margin	%	4.25%
Total assets turnover	×	3×
Equity multiplier	×	×

Answer 1

Below are the

Current Ratio		2.782609
Debt to total capital		6%
Times Interest Earned	8.093333
EBITDA coverage		11.2
Inventory Turnover		4.129032
Days sales Oustanding	38.54037
Fixed Asset Turnover	4.472222
Total Asset Turnover	1.61
Profit Margin		5%
Return on asset		8%
Return on common equity	11%
Return on invested capital	10%
Equity Mulitplier		1.388889

ROE using Dupont =

Net Income/ Sales * Sales / Total Assset * Total assets/ Common Equity

= 11%

The first component od Dupont is the profit margin = Net Income / Sales which evaluates the profit or the profitibility of the firm , in our case the profitibility of the firm is 5% which is above the industrial average of 4.25%. So it can be said the firm is performing better in terms of profitbility in terms profitbility.

The second component of the equation is Total Assets Turnover ratio which is sales / total asset which shows the asset efficiency of the firm, the firm has a asset turnover of 1.61 which is lower than the industrial average of 3 times. Signifying the firm is not able to utilise it's assets efficiently enough to generate sales.

The last component here is Equity Mulliplier which ascertains the financial leverage of the firm , which is a important indicator which analyses or measures the return of equity which is quite important for an investor. The firm has a equity multiplier of 1.39 . This is good indicator that the firm is not highly financial leverged and most of the assets are financed by equity rather debt or preference shares.

The firms ROE using the dupont Equation is 11% which is lower than the industrial average of 17.5% , thus the firm has to imrove the on asset turnover tom improve it's ROE , it can be by improving on sales and using assets more efficiently. e.g. if the asset turnover ratio becomes 2.1 the the ROE would be 14% and if the asset turnover ratio is 3 the the ROE becomes 21%. Thus the firm needs to focus more on sales to become more