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 3.24x Fixed assets turnover 7.56x Debt-to-capital ratio 19.22% Total assets turnover 3.62x Times interest earned 7.30x Profit margin 4.09% EBITDA coverage 9.59x Return on total assets 13.63% Inventory turnover 10.79x Return on common equity 21.57% Days sales outstandinga 25.45 days Return on invested capital 20.4% aCalculation is based on a 365-day year. Balance Sheet as of December 31, 2016 (Millions of Dollars) Cash and equivalents $37 Accounts payable $28 Accounts receivables 39 Other current liabilities 9 Inventories 81 Notes payable 28 Total current assets $157 Total current liabilities $65 Long-term debt 9 Total liabilities $74 Gross fixed assets 115 Common stock 58 Less depreciation 42 Retained earnings 98 Net fixed assets $73 Total stockholders' equity $156 Total assets $230 Total liabilities and equity $230 Income Statement for Year Ended December 31, 2016 (Millions of Dollars) Net sales $460.0 Cost of goods sold 363.4 Gross profit $96.6 Selling expenses 50.6 EBITDA $46.0 Depreciation expense 7.4 Earnings before interest and taxes (EBIT) $38.6 Interest expense 3.7 Earnings before taxes (EBT) $34.9 Taxes (40%) 14.0 Net income $20.9 Calculate the following ratios. Do not round intermediate steps. Round your answers to two decimal places. Firm Industry Average Current ratio x 3.24x Debt to total capital % 19.22% Times interest earned x 7.30x EBITDA coverage x 9.59x Inventory turnover x 10.79x Days sales outstanding days 25.45days Fixed assets turnover x 7.56x Total assets turnover x 3.62x Profit margin % 4.09% Return on total assets % 13.63% Return on common equity % 21.57% Return on invested capital % 20.40% 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 % 4.09% Total assets turnover x 3.62x Equity multiplier x x

Answer 1

Solution:-

(a).

Current ratio :-

Current ratio = current assets / Current liabilities

= 157 / 65

= $2.415

Current ratio = $2.41

Debt to total capital :-

Total debt = short term debt + long term debt

= 28 + 9

Total debt = $37

Debt to total capital = total debt / ( total debt + shareholders equity)

= ($37) / (37 + $156 )

= 37 / 193

= 0.1917

Debt to total capital = $0.19

Times interest earned:-

Times interest earned = income before interest and tax / interest expense

= 38.6 / 3.7

= 10.432

Times interest earned = $10.43

Inventory turnover :-

Inventory turnover = (inventory / cost of goods sold ) * 365

= ( 81 / 363.4) * 365

=0.222 * 365

= $81.356

Inventory turnover = $81.35

EBITDA coverage :-

EBITDA coverage = EBITDA / interest expenses

=  $46 / 3.7

= 12.432

EBITDA coverage = 12.43

Days sales outstanding days :-

Days sales outstanding days  = (Account receivable / total credit sales )* number of days

= ( 39 / 460) * 365

= 0.084 * 365

= 30.945

Days sales outstanding days = 30.94 days

Fixed assets turnover:-

Fixed assets turnover = sales / fixed assets

= 460 /  73

= 6.30

Fixed assets turnover = 6.30

Total assets turnover:-

Total assets turnover = sales / total assets

= 460 /  230

= 2

Total assets turnover = 2

Profit margin :-

Profit margin = net income / sales

= 20.9 / 460

= 0.0454 (or) 4.544%

Profit margin = 4.54%

Return on total assets :-

Return on total assets = net income / total assets

= 20.9 / 230

= 0.090 (or) 9.0%

Return on total assets = 9%

Return on common equity :-

Return on common equity = net income / shareholder equity

= 20.9 / 156

= 0.1339

Return on common equity = 0.13

Return on invested capital :-

Return on invested capital = net income / total assets

= 20.9 / 230

= 0.090 ( or) 9%

Return on invested capital = 9%

(b).

Profit margin:-

Profit margin = net income / sales

= 20.9 / 460

= 0.0454 (or) 4.54%

Profit margin = 4.54%

Total assets turnover :-

Total assets turnover = sales / total assets

= 460 /  230

= 2

Total assets turnover = 2

Equity multiplier :-

Equity multiplier = total assets / shareholder equity

= 230 / 156

= 1.4743

Equity multiplier = 1.47

DuPont equation for the firm and the industry :-

DuPont equation for the firm and the industry = ( Profit margin * Total assets turnover *  Equity multiplier)

= 4.54 * 2 * 1.47

= 13.3476

DuPont equation for the firm and the industry = 13.34