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 $1 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	2	×		Fixed assets turnover	6	×
Debt-to-capital ratio	17	%		Total assets turnover	3	×
Times interest earned	5	×		Profit margin	3.75	%
EBITDA coverage	8	×		Return on total assets	11.25	%
Inventory turnover	9	×		Return on common equity	15.20	%
Days sales outstandinga	24	days		Return on invested capital	15.10	%
aCalculation is based on a 365-day year.

Balance Sheet as of December 31, 2019 (Millions of Dollars)
Cash and equivalents	$	89		Accounts payable	$	56
Accounts receivables		78		Other current liabilities		28
Inventories		211		Notes payable		56
Total current assets	$	378		Total current liabilities	$	140
				Long-term debt		22
				Total liabilities	$	162
Gross fixed assets		266		Common stock		144
Less depreciation		89		Retained earnings		249
Net fixed assets	$	177		Total stockholders' equity	$	393
Total assets	$	555		Total liabilities and equity	$	555

Income Statement for Year Ended December 31, 2019 (Millions of Dollars)
Net sales	$	915.00
Cost of goods sold		760.00
Gross profit	$	155.00
Selling expenses		82.50
EBITDA	$	72.50
Depreciation expense		14.00
Earnings before interest and taxes (EBIT)	$	58.50
Interest expense		7.50
Earnings before taxes (EBT)	$	51.00
Taxes (25%)		12.75
Net income	$	38.25

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

   	Firm	Industry Average
   Current ratio	×	2	×
   Debt to total capital	%	17	%
   Times interest earned	×	5	×
   EBITDA coverage	×	8	×
   Inventory turnover	×	9	×
   Days sales outstanding	days	24	days
   Fixed assets turnover	×	6	×
   Total assets turnover	×	3	×
   Profit margin	%	3.75	%
   Return on total assets	%	11.25	%
   Return on common equity	%	15.20	%
   Return on invested capital	%	15.10	%

2. Construct a DuPont equation for the firm and the industry. Do not round intermediate calculations. Round your answers to two decimal places.

   	Firm	Industry
   Profit margin	%	3.75%
   Total assets turnover	×	3×
   Equity multiplier	×	×

Answer 1

a..	Formula	Firm		Ind. Av.	Analysis
Current ratio	Current assets/Current liabilities	378/140=	2.7	2	Better liquidity than industry average
Debt to total capital	LT debt/(LT debt+Equity)	22/(22+393)=	5.30%	17	Lesser debt funding of assets
Times interest earned	EBIT/Interest expense	58.5/7.5=	8	5	better coverage of interest expenses, due to lower debt-levels
EBITDA coverage	EBITDA/Interest expense	72.5/7.5=	10	8	better coverage of interest expenses, due to lower debt-levels
Inventory turnover	COGS/Inventory	760/211=	4	9	Inventory conversion to sales is more than half the time ,less than industry av.
Days sales outstanding	365/(Net sales/A/cs. Receivable)	365/(915/78)=	31	24	Sales collection also takes more no.of days than industry av.
Fixed assets turnover	Sales/Total fixed assets	915/177=	5	6	$ sales made per $ of fixed assets is less than ind. Av.
Total assets turnover	Sales/Total assets	915/555=	2	3	$ sales made per $ of total assets is less than ind. Av.
Profit margin	Net income/Sales	38.25/915=	4.18%	3.75	$ profit made per $100 of total sales is better than ind. Av.
Return on total assets	Net Income/Total assets	38.25/555=	6.89%	11.25	$ profit made per $100 of total assets   is just more than half of ind. Av.
Return on common equity	Net Income/Total Equity	38.25/393=	9.73%	15.2	$ profit made per $100 of total equity   is also lower than ind. Av.
Return on invested capital	Net Income/(LT Debt+Equity)	38.25/(22+393)=	9.22%	15.1	$ profit made per $100 of total capital employed    is also lower than ind. Av.
b.DuPont equation :		Firm		Ind.av.
Profit margin	Net income/Sales	38.25/915=	4.18%	3.75%	$ profit made per $100 of total sales is better than ind. Av.
Total assets turnover	Sales/Total assets	915/555=	2	3	$ sales made per $ of total assets is less than ind. Av.
Equity multiplier	Total assets/Total equity	555/393=	1.41	1.35	Despite having less of debt-funding , EM being slightly higher than ind. Av. Shows that the company carries unproductive assets , such as uncollected receivables,excessive inventory, etc. which drag down the asset-related profitability ratios also.
ROE=	PM*TATO*EM		9.73%	15.20%	Except for the marginal edge in profit margin ratio, the company lags behind in all other areas--- activity ratios (inventory , receivables & total assets)