Question

4) The following table presents a summary of ratio analysis for Target Inc and averages for its industry peer group: Profit margin Inventory turnover Asset turnover Target 8.0% 114.5 0.75 Industry Peer Group 7.0% 99.6 1.22 2.5 21.3% 12.0% Return on shareholders' equity Using the information provided above, use the DuPont framework to briefly summarize the operating performance of Target relative to its benchmark competitors. 3) Are differences between Target and the industry likely between Target and the industry likely driven by differences in size between Target and the average company in its industry peer group? Explain briefly. 4) Besides size differences, what other differences ability to make meaningful comparison ferences, what other differences between Target and its industry peer group could limit your meaningful comparisons about the performance of Target from the data above? his information, if you were going to advise Target about how it could enhance return on v. what would you suggest? Be as specific as possible in the operational or financial changes 5) Based on this information, if shareholders' equity, what would you sug you would recommend.

Answer 1

Using The Dupont Framework demonstrates Target is performing lower than its peers based on the discussion below: The Ratios cannot be seen in isolation and must be taken in conjunction, albeit with no actual performance figures or WACC revealed

Using the Dupont Framework;

[[[Return on Equity= Net Profit Margin x Asset Turnover Ratio x Financial Leverage

= (Net Income / Sales) x (Sales / Total Assets) x (Total Assets / Total Equity)]]]

Ergo:

Target=8.0% x 0.75 x 2= 12.%

Peer= 7% x 1.22 x 2.5= 21.3%

Answers:

2.1 It can be seen from the above ratios that Target is demonstrating a LOWER operating performance. It is converting its assets into cash at a lower ratio that its peers- despite a higher Profit Margins and Inventory Turnover. (8% PM vs 7% and Inventory turnover is 114 vs 99). This indicates it is generating a high level of COGS with lower Assets than its peers, (i.e. Inventory Turnover = COGS/Inventories)

2.2 it is possible that Peer Group is achieving higher Economies of Scale that Target. “Size” can be interpreted to mean size of sales network WITH higher capacity utilisation. Peer Group Asset turnover is 63% higher than Target and implies its operation efficiencies are higher by that multiple.

2.3 Absolute comparable figures of

(i) Revenues

(ii) Total Debt and WACC

(iii) Sales per Employee

(iv) Geographical Spread of Marketing and Sales

(iv) Revenue disaggregated by Product Mix

(v) Short Term Credit Terms/Policy

2.4

The equity multiplier is of Target is a debt and to equity financing ratio and must be examined how much Target is using Shareholder funds vs Credit to generation a higher RoE under the DuPont Framework.

The Peer Group reveals that 43.3% higher that Target. (2.5 vs 2)

This implies Peer group’s higher ratio were funded by more debt than by shareholder funds (equity).

We assume when a firm’s assets are primarily funded by debt, the firm is highly leveraged and usually riskier for investors and creditors. But Peer Groups Higher Debt makes its interest payment Tax Deductible and indicates that Creditors are providing more credit because they view it as a lower risk.

Target’s lower equity multiple (2) ratio can be construed as more conservative and usually more favourable than Peer Group’s higher ratios because companies with lower ratios are less dependent on debt financing and don’t have high debt servicing costs. Peer Groups higher ratio may indicate THIS IS NOT NECESSARILY TRUE IN A BOOM ECONOMY with lower financing costs and higher credit offtake.

Peer Group’s finances its assets by 25% MORE debt than Target. This has resulted in a higher return on equity (RoE) using Dupont Framework alone and my advice to Target

1. would be to increase Targets used of Debt (increase Financial leverage)
2. Because its Asset Turn Over is Lower than Peers. It’s important to increase Targets Capacity utilization and Sales Turnover. This can be achieved by Lowering profit margins to increase sales to match Asset Turnover to Peer Group and Raise RoE under the Dupont Framework