Question

Refer to the following data:

Selected Ratios: SKI and Industry Average
	SKI	Industry
Current	1.75	2.25
Debt/Assets	58.76%	50.00%
Turnover of cash and securities	16.67	22.22
Days sales outstanding (365-day basis)	45.63	32
Inventory turnover	4.82	7
Fixed assets turnover	11.35	12
Total assets turnover	2.08	3
Profit margin	2.07%	3.50%
Return on equity (ROE)	10.45%	21.00%

Answer the following questions:

1. a. Determine the DuPont Equation using available data

   b. Analyze and interpret in comparison with industry as benchmark

2. a. Determine the EVA using available data (make reasonable assumptions)

   b. Analyze and interpret

   c. Examine factors in DuPont equation which could be modified to generate a higher EVA for SKI

Answer 1

1.

DuPont Equation : ROE = Profit margin * Total assets turnover * Assets / Equity

Now in the given data, we have Debt / Asset

So, Equity / Assets = 1 - Debt / Assets

SKI :

Debt / Assets = 58.76%

Equity / assets = 1 - 0.5876 =  0.4124 = 41.24%

So Asset / Equity = 1 / 0.4124 = 2.425

Profit margin = 2.07%

Total assets turn over = 2.08

So

ROE = 2.07% * 2.08 * 2.425 = 10.44%

Industry :

Debt / Assets = 50%

Equity / assets = 1 - 0.50 =  0.50= 50%

So Asset / Equity = 1 / 0.5 = 2

Profit margin = 3.5%

Total assets turn over = 3

So

ROE = 3.5% * 3 * 2 = 21%

If you compare the components of ROE in SKI and industry, you will see that :

1. Profit margin of SKI is less than Industry, which is one of the reason that ROE is lower

2. Assets turnover is also lower for SKI compared to industry, so it means that they are not utilizing their assets well to generate revenue. This is also major reason of lower ROE

3. Leverage of SKI is higher than Industry, which has impacted the ROE of SKI in positive manner.

2.

Economic Value Added EVA formula= Net Operating Profit After Tax – (Capital Invested x WACC)

So given data, we need to assume lot of variables and it is not possible to calculate by given data. I do not want to give you wrong answer

3. SKI simply need to increase there Operating profits which will flow down and will increase Net profit and eventually Profit margin. This will improve the ROE. So SKI needs to use their assets efficiently and need to reduce their operation costs.

Increasing WACC by putting move equity will also improve EVA, but due to more equity, leverage effect will get lower and it will have -ve effect on ROE, so this is not recommended.