Question

Refer to the statement. Compute ROE for both 2017 and 2016. Use DuPont Analysis to check for the problem of lower ROE year.

Balance Sheet: 12/31/17 Assets 2016 2017 1040 Cash and Marketable Securities 130 4095 4875 Accounts Receivable 5395 7995 Inventories 10530 13000 Total Current Assets 13000 11310 Net plant and equipment 21840 26000 TOTAL ASSETS 2016 2017 Liabilities and Equity Accounts Payable Notes Payable Accruals 520 780 780 1820 1690 1430 2990 4030 Total Current Liabilities 7540 9802 Long Term Bonds TOTAL DEBT 10530 13832 520 520 Preferred Stock 1690 1690 Common Stock 9100 9958 Retained earnings TOTAL COMMON EQUITY 10790 21840 11648 26000 TOTAL LIABILITIES AND EQUITY 2016 2017 Income Statement: 12/31/17 37050 41600 Net Sales 32461 35100 Operating Costs (excludes Dep/Amortization) 4589 6500 EBITDA 1170 1300 Depreciation Amortization 1170 1300 Depreciation and Amortization 3419 5200 EBIT 780 1144 Less Interest 2639 4056 EBT 105.56 1622.4 Taxes (40%) NET INCOME (before Preferred Dividends) 1583.4 2433.6 52 52 Preferred Dividends 1531.4 2381.6 NET INCOME 689 1521 Common Dividends 842.4 860.6 Addition to Retained Earnings

Answer 1

From the given financial statements, we can calculate the ROE as below:

ROE calculation

Year	2017	2016
Net Income	2381.6	1531.4
Common equity	11648	10790
ROE (Net income / Common equity)	20%	14%

We can see ROE is lower for 2016.

DuPont Analysis is used individually categorize the key financial metrics to analyze the reason for low ROE.

Hence ROE= Net Income / Common equity

= (Net income / Revenue)* (Revenue/ Average total assets) * (Average total assets/ Common equity)

=Net profit Margin * Asset Turnover * Leverage

When we calculate the above parameters for the two years as below.

Year	2017	2016
Net Income	2381.6	1531.4
Net Sales	41600	37050
Net Profit Margin (Net income / Net sales)	6%	4%
Net sales	41600	37050
Assets	26000	21840
Asset Turnover (Net sales/ Assets)	1.6	1.7
Assets	26000	21840
Common Equity	11648	10790
Leverage (Assets/Common equity)	2.2	2.0

From the above table, we can understand that the company increased profit margin from 2016 to 2017 and also increased leverage by increasing more debt than increase in equity, thus reducing equity % helped the company to improve ROE in 2017.

Less profit margin and less leverage is reason for low ROE in 2016.