Question

Question 2 (Total marks= 20)
Adams Corporation manufactures fasteners. The company’s income statements for three years are indicated in Exhibit 1. The balance Sheets for the same period are shown in Exhibit 2.
Exhibit 1
ADAMS CORPORATION
Income Statement
2017
2018
2019
Sales (all on credit)…………………………
$1,500,000
$1,800,000
$2,160,000
Cost of goods sold………………………
950,000
1,120,000
1,300,000
Gross profit…………………………………
550,000
680,000
860,000
Selling and administrative expense………
380,000
490,000
590,000
Operating profit……………………………
170,000
190,000
270,000
Interest expense…………………….....
30,000
40,000
85,000
Net income before taxes…………………
140,000
150,000
185,000
Taxes…………………………………………
46,120
48,720
64,850
Net Income……………………………..
$93,880
$101,280
$120,150
Shares………………………………………
40,000
40,000
46,000
Exhibit 2
ADAMS CORPORATION
Balance Sheet
Assets
2017
2018
2019
Cash………………………………………………
$20,000
$30,000
$20,000
Marketable securities…………………………
30,000
35,000
50,000
Accounts receivable………………………………
150,000
230,000
330,000
Inventory……………………………………
250,000
285,000
325,000
Total Current Assets………………………………
450,000
580,000
725,000
Net Plant and equipment……………………………
550,000
720,000
1,169,000
Total Assets………………………………………..
$1,000,000
$1,300,000
$1,894,000
Liabilities & Equity
Accounts payable…………………………….
$100,000
$225,000
$200,000
Notes payable (bank)………………………………
100,000
100,000
300,000
Total Current liabilities……………………………
200,000
325,000
500,000
Long-term liabilities……………………………
250,000
331,120
550,740
Total liabilities………………………………………
450,000
656,120
1,050,740
Common stock ($10 par)……………………
400,000
400,000
460,000
Capital paid in excess of par……………….
50,000
50,000
80,000
Retained earnings…………………………………
100,000
193,880
303,260
Total stockholders’ equity……………………………..
550,000
643,880
843,260
Total liabilities and stockholders’ equity………………
$1,000,000
$1,300,000
$1,894,000
(a) Using the Du Pont System, describe the changes in the return on assets from year to year and analyze the factors affecting the ROA. (8 marks)

Answer 1

Using the Du Pont system, the return on assets (ROA) will be broken down as under:

2017 2018 2019 6.26% 5.63% Ratio Profit Margin Asset Turnover ROA 1.50 1.38 7.77% 5.56% 1.14 6.34% 9.39%

As evident from the table above, ROA of the company has been declining over the last 3 years. The factors contributing to this drop are both dropping profit margins as well as deteriorating Asset Tunrover. The company has been able to grow its sales but corresponding to the increase in revenues, costs are also increases resulting in redcued profitability. The company also has not been able to use its assets effectively in 2018 and 2019 which has resulted in lower Asset Turnover.

Workings

Under DuPont Analysis, ROA is calculated as Net Profit Margin* Asset Turnover

Net Profit Margin = Net Income/Net Sales

Asset Turnover = Net Sales/Total Assets

Ratio Formula Profit Margin Net Income/Net Sales working Asset Turnover Net Sales/Total Assets working ROA Profit Margin * Asset Turnover working 2017 2018 2019 6.26% 5.63% 5.56% |=93880/1500000 =101280/1800000 =120150/2160000 1.50 1.38 1.14 |=1500000/1000000 =1800000/1300000 =2160000/1894000 9.39% 7.77% 6.34% =6.26%*1.5 =5.63%*1.38 =5.56%*1.14

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