A sheaf of papers in her hand, your friend and colleague, Chloe, steps into your office and asked the following. CHLOE: Do you have 10 or 15 minutes that you can spare? YOU: Sure, I’ve got a meeting in an hour, but I don’t want to start something new and then be interrupted by the meeting, so how can I help? CHLOE: I’ve been reviewing the company’s financial statements and looking for ways to improve our performance, in general, and the company’s return on equity, or ROE, in particular. Eric, my new team leader, suggested that I start by using a DuPont analysis, and I’d like to run my numbers and conclusions by you to see whether I’ve missed anything. Here are the balance sheet and income statement data that Eric gave me, and here are my notes with my calculations. Could you start by making sure that my numbers are correct? YOU: Give me a minute to look at these financial statements and to remember what I know about the DuPont analysis. Balance Sheet Data Income Statement Data Cash $600,000 Accounts payable $720,000 Sales $12,000,000 Accounts receivable 1,200,000 Accruals 240,000 Cost of goods sold 7,200,000 Inventory 1,800,000 Notes payable 960,000 Gross profit 4,800,000 Current assets 3,600,000 Current liabilities 1,920,000 Operating expenses 3,000,000 Long-term debt 2,400,000 EBIT 1,800,000 Total liabilities 4,320,000 Interest expense 403,200 Common stock 720,000 EBT 1,396,800 Net fixed assets 3,600,000 Retained earnings 2,160,000 Taxes 349,200 Total equity 2,880,000 Net income $1,047,600 Total assets $7,200,000 Total debt and equity $7,200,000 If I remember correctly, the DuPont equation breaks down our ROE into three component ratios: the , the total asset turnover ratio, and the . And, according to my understanding of the DuPont equation and its calculation of ROE, the three ratios provide insights into the company’s , effectiveness in using the company’s assets, and . Now, let’s see your notes with your ratios, and then we can talk about possible strategies that will improve the ratios. I’m going to check the box to the side of your calculated value if your calculation is correct and leave it unchecked if your calculation is incorrect. Hydra Cosmetics Inc. DuPont Analysis Ratios Value Correct/Incorrect Ratios Value Correct/Incorrect Profitability ratios Asset management ratio Gross profit margin (%) 40.00 Total assets turnover 1.67 Operating profit margin (%) 11.64 Net profit margin (%) 14.55 Financial ratios Return on equity (%) 40.58 Equity multiplier 1.67 CHLOE: OK, it looks like I’ve got a couple of incorrect values, so show me your calculations, and then we can talk strategies for improvement. YOU: I’ve just made rough calculations, so let me complete this table by inputting the components of each ratio and its value: Do not round intermediate calculations and round your final answers up to two decimals. Hydra Cosmetics Inc. DuPont Analysis Ratios Calculation Value Profitability ratios Numerator Denominator Gross profit margin (%) / = Operating profit margin (%) / = Net profit margin (%) / = Return on equity (%) / = Asset management ratio Total assets turnover / = Financial ratios Equity multiplier / = CHLOE: I see what I did wrong in my computations. Thanks for reviewing these calculations with me. You saved me from a lot of embarrassment! Eric would have been very disappointed in me if I had showed him my original work. So, now let’s switch topics and identify general strategies that could be used to positively affect Hydra’s ROE. YOU: OK, so given your knowledge of the component ratios used in the DuPont equation, which of the following strategies should improve the company’s ROE? Check all that apply. Decrease the amount of debt financing used by the company, which will decrease the total assets turnover ratio. Decrease the company’s use of debt capital because it will decrease the equity multiplier. Increase the firm’s bottom-line profitability for the same volume of sales, which will increase the company’s net profit margin. Use more debt financing in its capital structure and increase the equity multiplier. CHLOE: I think I understand now. Thanks for taking the time to go over this with me, and let me know when I can return the favor.

A sheaf of papers in her hand, your friend and colleague, Chloe, steps into your office and asked the following. CHLOE: Do you have 10 or 15 minutes that you can spare? YOU: Sure, I’ve got a meeting in an hour, but I don’t want to start something new and then be interrupted by the meeting, so how can I help? CHLOE: I’ve been reviewing the company’s financial statements and looking for ways to improve our performance, in general, and the company’s return on equity, or ROE, in particular. Eric, my new team leader, suggested that I start by using a DuPont analysis, and I’d like to run my numbers and conclusions by you to see whether I’ve missed anything. Here are the balance sheet and income statement data that Eric gave me, and here are my notes with my calculations. Could you start by making sure that my numbers are correct? YOU: Give me a minute to look at these financial statements and to remember what I know about the DuPont analysis. Balance Sheet Data Income Statement Data Cash $600,000 Accounts payable $720,000 Sales $12,000,000 Accounts receivable 1,200,000 Accruals 240,000 Cost of goods sold 7,200,000 Inventory 1,800,000 Notes payable 960,000 Gross profit 4,800,000 Current assets 3,600,000 Current liabilities 1,920,000 Operating expenses 3,000,000 Long-term debt 2,400,000 EBIT 1,800,000 Total liabilities 4,320,000 Interest expense 403,200 Common stock 720,000 EBT 1,396,800 Net fixed assets 3,600,000 Retained earnings 2,160,000 Taxes 349,200 Total equity 2,880,000 Net income $1,047,600 Total assets $7,200,000 Total debt and equity $7,200,000 If I remember correctly, the DuPont equation breaks down our ROE into three component ratios: the , the total asset turnover ratio, and the . And, according to my understanding of the DuPont equation and its calculation of ROE, the three ratios provide insights into the company’s , effectiveness in using the company’s assets, and . Now, let’s see your notes with your ratios, and then we can talk about possible strategies that will improve the ratios. I’m going to check the box to the side of your calculated value if your calculation is correct and leave it unchecked if your calculation is incorrect. Hydra Cosmetics Inc. DuPont Analysis Ratios Value Correct/Incorrect Ratios Value Correct/Incorrect Profitability ratios Asset management ratio Gross profit margin (%) 40.00 Total assets turnover 1.67 Operating profit margin (%) 11.64 Net profit margin (%) 14.55 Financial ratios Return on equity (%) 40.58 Equity multiplier 1.67 CHLOE: OK, it looks like I’ve got a couple of incorrect values, so show me your calculations, and then we can talk strategies for improvement. YOU: I’ve just made rough calculations, so let me complete this table by inputting the components of each ratio and its value: Do not round intermediate calculations and round your final answers up to two decimals. Hydra Cosmetics Inc. DuPont Analysis Ratios Calculation Value Profitability ratios Numerator Denominator Gross profit margin (%) / = Operating profit margin (%) / = Net profit margin (%) / = Return on equity (%) / = Asset management ratio Total assets turnover / = Financial ratios Equity multiplier / = CHLOE: I see what I did wrong in my computations. Thanks for reviewing these calculations with me. You saved me from a lot of embarrassment! Eric would have been very disappointed in me if I had showed him my original work. So, now let’s switch topics and identify general strategies that could be used to positively affect Hydra’s ROE. YOU: OK, so given your knowledge of the component ratios used in the DuPont equation, which of the following strategies should improve the company’s ROE? Check all that apply. Decrease the amount of debt financing used by the company, which will decrease the total assets turnover ratio. Decrease the company’s use of debt capital because it will decrease the equity multiplier. Increase the firm’s bottom-line profitability for the same volume of sales, which will increase the company’s net profit margin. Use more debt financing in its capital structure and increase the equity multiplier. CHLOE: I think I understand now. Thanks for taking the time to go over this with me, and let me know when I can return the favor.

FINANCIAL ACCOUNTING

10th Edition

ISBN:9781259964947

Author:Libby

Publisher:Libby

Chapter1: Financial Statements And Business Decisions

Section: Chapter Questions

Problem 1Q

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Question

A sheaf of papers in her hand, your friend and colleague, Chloe, steps into your office and asked the following.

CHLOE: Do you have 10 or 15 minutes that you can spare?

YOU: Sure, I’ve got a meeting in an hour, but I don’t want to start something new and then be interrupted by the meeting, so how can I help?

CHLOE: I’ve been reviewing the company’s financial statements and looking for ways to improve our performance, in general, and the company’s return on equity, or ROE, in particular. Eric, my new team leader, suggested that I start by using a DuPont analysis, and I’d like to run my numbers and conclusions by you to see whether I’ve missed anything.

Here are the balance sheet and income statement data that Eric gave me, and here are my notes with my calculations. Could you start by making sure that my numbers are correct?

YOU: Give me a minute to look at these financial statements and to remember what I know about the DuPont analysis.

Balance Sheet Data	Income Statement Data
Cash	$600,000	Accounts payable	$720,000	Sales	$12,000,000
Accounts receivable	1,200,000	Accruals	240,000	Cost of goods sold	7,200,000
Inventory	1,800,000	Notes payable	960,000	Gross profit	4,800,000
Current assets	3,600,000	Current liabilities	1,920,000	Operating expenses	3,000,000
		Long-term debt	2,400,000	EBIT	1,800,000
		Total liabilities	4,320,000	Interest expense	403,200
		Common stock	720,000	EBT	1,396,800
Net fixed assets	3,600,000	Retained earnings	2,160,000	Taxes	349,200
		Total equity	2,880,000	Net income	$1,047,600
Total assets	$7,200,000	Total debt and equity	$7,200,000

If I remember correctly, the DuPont equation breaks down our ROE into three component ratios: the , the total asset turnover ratio, and the .

And, according to my understanding of the DuPont equation and its calculation of ROE, the three ratios provide insights into the company’s , effectiveness in using the company’s assets, and .

Now, let’s see your notes with your ratios, and then we can talk about possible strategies that will improve the ratios. I’m going to check the box to the side of your calculated value if your calculation is correct and leave it unchecked if your calculation is incorrect.

Hydra Cosmetics Inc. DuPont Analysis

Ratios	Value	Ratios	Value
Profitability ratios		Asset management ratio
Gross profit margin (%)	40.00	Total assets turnover	1.67
Operating profit margin (%)	11.64
Net profit margin (%)	14.55	Financial ratios
Return on equity (%)	40.58	Equity multiplier	1.67

CHLOE: OK, it looks like I’ve got a couple of incorrect values, so show me your calculations, and then we can talk strategies for improvement.

YOU: I’ve just made rough calculations, so let me complete this table by inputting the components of each ratio and its value:

Do not round intermediate calculations and round your final answers up to two decimals.

Hydra Cosmetics Inc. DuPont Analysis

Ratios	Calculation		Value
Profitability ratios	Numerator		Denominator
Gross profit margin (%)		/		=
Operating profit margin (%)		/		=
Net profit margin (%)		/		=
Return on equity (%)		/		=
Asset management ratio
Total assets turnover		/		=
Financial ratios
Equity multiplier		/		=

CHLOE: I see what I did wrong in my computations. Thanks for reviewing these calculations with me. You saved me from a lot of embarrassment! Eric would have been very disappointed in me if I had showed him my original work.

So, now let’s switch topics and identify general strategies that could be used to positively affect Hydra’s ROE.

YOU: OK, so given your knowledge of the component ratios used in the DuPont equation, which of the following strategies should improve the company’s ROE?

Check all that apply.

Decrease the amount of debt financing used by the company, which will decrease the total assets turnover ratio.

Decrease the company’s use of debt capital because it will decrease the equity multiplier.

Increase the firm’s bottom-line profitability for the same volume of sales, which will increase the company’s net profit margin.

Use more debt financing in its capital structure and increase the equity multiplier.

CHLOE: I think I understand now. Thanks for taking the time to go over this with me, and let me know when I can return the favor.

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