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 $3 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	3.62x		Fixed assets turnover	5.36x
Debt-to-capital ratio	16.99%		Total assets turnover	3.02x
Times interest earned	28.62x		Profit margin	8.80%
EBITDA coverage	18.64x		Return on total assets	26.00%
Inventory turnover	9.28x		Return on common equity	38.44%
Days sales outstandinga	23.12 days		Return on invested capital	30.63%

^aCalculation is based on a 365-day year.

Balance Sheet as of December 31, 2016 (Millions of Dollars)
Cash and equivalents	$59		Accounts payable	$31
Accounts receivables	45		Other current liabilities	10
Inventories	125		Notes payable	35
Total current assets	$229		Total current liabilities	$76
			Long-term debt	17
			Total liabilities	$93
Gross fixed assets	157		Common stock	97
Less depreciation	38		Retained earnings	158
Net fixed assets	$119		Total stockholders' equity	$255
Total assets	$348		Total liabilities and equity	$348

Income Statement for Year Ended December 31, 2016 (Millions of Dollars)
Net sales	$580.0
Cost of goods sold	411.8
Gross profit	$168.2
Selling expenses	52.2
EBITDA	$116.0
Depreciation expense	16.8
Earnings before interest and taxes (EBIT)	$99.2
Interest expense	2.6
Earnings before taxes (EBT)	$96.6
Taxes (40%)	38.6
Net income	$58.0

1. Calculate the following ratios. Do not round intermediate steps. Round your answers to two decimal places.

   	Firm	Industry Average
   Current ratio	x	3.62x
   Debt to total capital	%	16.99%
   Times interest earned	x	28.62x
   EBITDA coverage	x	18.64x
   Inventory turnover	x	9.28x
   Days sales outstanding	days	23.12days
   Fixed assets turnover	x	5.36x
   Total assets turnover	x	3.02x
   Profit margin	%	8.80%
   Return on total assets	%	26.00%
   Return on common equity	%	38.44%
   Return on invested capital	%	30.63%

2. 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	%	8.80%
   Total assets turnover	x	3.02x
   Equity multiplier	x	x

Answer 1

a) i) Current ratio = Current assets / Current liabilities

Current ratio = $229 / $76 = 3.01

ii) Debt to total capital = Interest bearing liabilities / (Interest bearing liabilities + Shareholders equity)

Interest bearing liabilities (Long term debt + Notes payable) = $17 + $35 = $52

Stockholders equity = $255

Now,

Debt to total capital = $52 / ($52 + $255) = 0.1694 or 16.94%

iii) Times interest earned =  EBIT / Interest

Times interest earned = $99.20 / $2.60 = 38.15

iv) EBITDA coverage = (EBITDA + Lease payment) / (Loan payment + Lease payment)

Here, lease payment = Nil,

Loan payment (sinking fund) = $3

EBITDA coverage = $116 / $3 = 38.67

v) Inventory turnover = Cost of goods sold / Inventory

Inventory turnover = $411.80 / $125 = 3.29

vi) Days sales outstanding = (Recievables / Credit sales) * 365 days

Days sales outstanding = ($45 / $580) * 365 days

Days sales outstanding = 28.32 days

vii) Fixed assets turnover = Net sales / Net fixed assets

Fixed assets turnover = $580 / $119 = 4.87

viii) Total assets turnover = Net sales /Total assets

Total assets turnover = $580 / $348 = 1.67

ix) Profit margin = Net income / Net sales

Profit margin = $58 / $580 = 0.10 or 10%

x) Return on total assets=Net income/Total assets

Return on total assets = $58 / $348 = 0.167 or 16.7%

xi) Return on common equity = Net income / Stockholders equity

Return on common equity = $58 / $255 = 0.2275 or 22.75%

xii) Return on invested capital = Net income / Invested capital

Here, Invested capital = Long term debt + Stockholders equity

Ingested capital = $17 + $255 = $272

Now,

Return on invested capital = $58 / $272 = 0.2132 or 21.32%

Particulars	Firm	Industry Average	Good or Bad compared to industry average
Current ratio	3.01	3.62	Bad
Debt to total capital	16.94%	16.99%	Good
Times interest earned	38.15	28.62	Good
EBITDA coverage	38.67	18.64	Good
Inventory turnover	3.29	9.28	Bad
Days sales outstanding	28.32 days	23.12 days	Bad
Fixed assets turnover	4.87	5.36	Good
Total assets turnover	1.67	3.02	Bad
Profit margin	10.00%	8.80%	Good
Return on total assets	16.70%	26.00%	Bad
Return on common equity	22.75%	38.44%	Bad
Return on invested capital	21.32%	30.63%	Bad

b) DuPont equation :

For firm :

Profit margin = 0.10,

Total assets turnover = 1.67

Equity multiplier = Total assets / Total shareholder's equity

Equity multiplier = $348 / $255 = 1.36

Now,

DuPont equation = Profit margin * Total assets turnover * Equity multiplier

DuPont equation = 0.10 * 1.67 * 1.36 = 0.2271