Question

Consider the following financia statements for Green Valley Nursing Home, Inc., a for-profit, long term care facility:
	Green Valley Nursing Home, Inc., Statement of Income and Rretained Earnings, Year-ended December 31, 2015								Green Valley Nursing home, Inc., Balance sheet, December 31, 2015
	Revenue:								Assets
		Net patient service revenue				$ 3,163,258.00			Current assets:
		other revenue				$      106,146.00				cash				$      105,737.00
		total revenues				$ 3,269,404.00				marketable securities				$      200,000.00
	Expenses:									net patient accounts receivable				$      215,600.00
		salaries and benefits				$ 1,515,438.00				supplies				$        87,655.00
		medical supplies and drugs				$      966,781.00				total current assets				$      608,992.00
		insurance				$      296,357.00				property and equipment				$ 2,250,000.00
		provision for bad debts				$      110,000.00				less accumulated depreciation				$      356,000.00
		depreciation				$        85,000.00				net property and equipment				$ 1,894,000.00
		interest				$      206,780.00				total assets				$ 2,502,992.00
		total expenses				$ 3,180,356.00
		operating income				$        89,048.00			liabilities and shareholders equity
		provision for income taxes				$        31,167.00			current liabilities:
		net income				$        57,881.00				accounts payable				$        72,250.00
										accrued expenses				$      192,900.00
		retained earning, beginning of year				$      199,961.00				notes payable				$      100,000.00
		retained earnings, end of year				$      257,842.00				current portion of long term debt				$        80,000.00
										total current liabilities				$      445,150.00
										long-term debt				$ 1,700,000.00
									shareholders' equity
										common stock, $10 per value				$      100,000.00
										retained earnings				$      257,842.00
										total shareholders' equity				$      357,842.00
										total liabilities and shareholders' equity				$ 2,502,992.00
A	perform a Du Pont analysis on Green Valley. Assume that the industry avergae ratios are as follows:
	total margin			3.5%
	total asset turnover			1.5
	equity multiplier			2.5
	return on equity (ROE)			13.1%

Answer 1

ROE = Profit Margin (Profit/Sales) * Total Asset Turnover (Sales/Assets) * Equity Multiplier (Assets/Equity)

Profit Margin = Profit/Sales = 57,881/3,269,404 = 1.77%

Total Asset Turnover = Sales/Assets = 3,269,404/2,502,992 = 1.31

Equity Multiplier = Assets/Equity = 2,502,992/357,842 = 6.99

ROE = 16.175%

Green Valley's ROE is greater than the industry average but its profit margin and total asset turnover are lower than industrial average but the difference in ROEs is due to the Equity multiplier which means higher equity multiplier indicates that a larger portion of asset financing is attributed to debt.Hence, it is a much riskier company than the industry average, even though, its ROE is higher than the industrial average.