Question

4-24 6x 3x 66 DUPONT ANALYSIS A firm has been experiencing low profitability in recent years. Per- form an analysis of the firm's financial position using the DuPont equation. The firm has no lease payments but has a $2 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 3x Fixed assets turnover Debt-to-capital ratio 20% Total assets turnover Times interest earned 7x Profit margin 39 EBITDA coverage 9x Return on total assets 996 Inventory turnover 10x Return on common equity 12.86% Days sales outstanding 24 days Return on invested capital 11.50% "Calculation is based on a 365-day year. Balance Sheet as of December 31, 2014 (Millions of dollars) Cash and equivalents $ 78 Accounts payable $ 45 Accounts receivable Other current liabilities 11 Inventories 159 Notes payable 29 Total current assets $303 Total current liabilities $ 85 Long-term debt 50 Total liabilities $135 Gross fixed assets 225 Common stock 114 Less depreciation 78 Retained earnings 201 Net fixed assets $147 Total stockholders' equity $315 Total assets $450 Total liabilities and equity $450 Income Statement for Year Ended December 31, 2014 (Millions of dollars) Net sales $795.0 Cost of goods sold 6600 Gross profit $135.0 Selling expenses 735 EBITDA $ 615 Depreciation expense 12.0 Earnings before interest and taxes (EBIT) $ 49.5 Interest expense 45 Earnings before taxes (EBT) $ 45.0 Taxes (40%) 18.0 Net income $ 270 a. Calculate the ratios you think would be useful in this analysis. b. Construct a DuPont equation and compare the company's ratios to the industry average ratios. c. Do the balance sheet accounts or the income statement figures seem to be primarily responsible for the low profits? d. Which specific accounts seem to be most out of line relative to other firms in the industry? e. If the firm had a pronounced seasonal sales pattem or if it grew rapidly during the year, how might that affect the validity of your ratio analysis? How might you correct for such potential problems?

please answer question E

please answer A to E please

Answer 1

solution a : Ratio Analysis :

RATIO	COMPANY
Current Ratio	3.56
Debt to Total Capital	20.05 %
Times interest earned	11
EBITDA COVERAGE	9.46
INVENTORY T/O	5
Days sales outstanding	30.28 days
FIXED ASSEST T/O	5.41
TOTAL ASSEST T/O	1.77
PROFIT MARGIN	3.396 %
RETURN ON TOTAL ASSEST	11 %
RETURN ON COMMON EQUITY	8.57 %
RETURN ON INVESTED CAPITAL	6 %

EXPLANATION :

Current Ratio = current assets / current liabilities

= 303/85

= 3.56

Debt to Total Capital = total Debt / total invested capital

=29 + 50 / ( 29 + 50 + 315)

=20.05 %

Times interest earned = EBIT /INTEREST

=49.5/4.50

= 11 TIMES

EBITDA COVERAGE =(EBIT + LEASE PAYMENT ) /(INTEREST +PRINCIPAL PAYMENT + LEASE PAYMENT)

= 61.5 /(4.50 + 2)
=9.46 Times

INVENTORY T/O = SALES / INVENTORIES

= 795 /159

=5 times

Days sales outstanding = Accounts Receivable /Total Credit sales

=66/( 795/365)

= 66/2.18

=30.28 days

FIXED ASSEST T/O = NET SALES /NET FIXED ASSEST

= 795 /147

= 5.41 TIMES

TOTAL ASSEST T/O =NET SALES / TOTAL ASSEST

= 795 /450

=1.77 TIMES

PROFIT MARGIN = NET INCOME /SALES

=27 /795

=3.396 %

RETURN ON TOTAL ASSEST = net income /TOTAL ASSEST

=27 /450

= 6 %

RETURN ON COMMON EQUITY = NET INCOME / EQUITY

=27 /315

= .0857 OR 8.57 %

RETURN ON INVESTED CAPITAL = NET INCOME / TOTAL LIABILITY & EQUITY

=27 /450

= .06 OR 6 %

SOLUTION 2 : construction of Du Pont Equation :

DU PONT EQUATION = PROFIT MARGIN X TOTAL ASSEST T/O X EQUITY MULTIPLIER*

=3.396 % X1.77 X1.4286*

= 8.57 %

* EQUITY MULTIPLIER = TOTAL ASSETS /TOTAL COMMON EQUITY

= 450/315

=1.4286

RATIO	COMPANY	INDUSTRY AVERAGE	PERFORMANCE
Current Ratio	3.56	3	GOOD
Debt to Total Capital	20.05 %	20 %	GOOD
Times interest earned	11	7	GOOD
EBITDA COVERAGE	9.46	9	GOOD
INVENTORY T/O	5	10	BAD
Days sales outstanding	30.28 days	24 days	BAD
FIXED ASSEST T/O	5.41	6	BAD
TOTAL ASSEST T/O	1.77	3	BAD
PROFIT MARGIN	3.396 %	3	GOOD
RETURN ON TOTAL ASSEST	11 %	9 %	GOOD
RETURN ON COMMON EQUITY	8.57 %	12.86%	BAD
RETURN ON INVESTED CAPITAL	6 %	11.50 %	BAD

SOLUTION C& D

Continuing fromthe DuPont analysis , we can see that profit margin and equity multiplier of the company are performing good relative to the industry.This means the company is employing a good level of debt relative to the industry and its cost efficiency is good..

However , the rate of return on equity and assets and total assets turnover are way below the industry average. This would indicate that the company has more assest then it needs, or the assest aren't performing good as they should have .Thus the balance sheet accounts would seems to be primarily responsible for the low return ratios.

The specific accounts for this would be inventories and accounts receivable.

Upon further analysis we can see that the company is indeed holding more inventory and accounts receivable than necessary .inventory t/o 5x is twice lower than industry average.

solution e:

Sesonal sales pattern or massive growth rate in a year might affectthe validity of the ratio analysis,as this might significantly skew important income statement and balance sheet amounts used in such analysis.

using periodic averages of affected accounts such as inventory and receivable when computing turnover ratios might help compensate for such changes.

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