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Chapter 2: 2DQ (page 74)

Explain how the Du Pont system of analysis breaks down return on assets. Also explain how it breaks down return on stockholders鈥� equity

Short Answer

Expert verified

With the Du Pont system of analysis, the return on assets is calculated by multiplying the net profit margin with the total assets turnover. And the return on the stockholder鈥檚 equity is calculated by multiplying the return on the asset with the equity multiplier.

Step by step solution

01

Definition

The Du Pont analysis breaks down the equation of Return on Equity (ROE) into three parts:

  • Profitability is measured by the profit margin (Net income/Revenue)
  • Asset efficiency is measured by asset turnover(Revenue/Average Total Assets)
  • Financial leverage is measured by the equity multiplier(Average Total Assets/Average Total Equity)

02

 By the Du Pont system, return on assets is broken down as

03

By the Du Pont system, the return on stockholder’s equity is broken down as

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Most popular questions from this chapter

Lenow鈥檚 Drug Stores and Hall鈥檚 Pharmaceuticals are competitors in the discount drug chain store business. The separate capital structures for Lenow and Hall are presented here:

Lenow

Hall

Debt @ 10%

\(100,000

Debt @ 10%

\)200,000

Common stock, \(10 par

200,000

Common stock, \)10 par

100,000

Total

\(300,000

Total

\)300,000

Shares

20,000

Common shares

10,000

a. Compute earnings per share if earnings before interest and taxes are \(20,000, \)30,000, and $120,000 (assume a 30 percent tax rate).

Conn Man鈥檚 Shops, a national clothing chain, had sales of \(350 million last year. The business has a steady net profit margin of 9 percent and a dividend payout ratio of 25 percent. The balance sheet for the end of last year is shown next. The firm鈥檚 marketing staff has told the president that in the coming year

there will be a large increase in the demand for overcoats and wool slacks. A

sales increase of 20 percent is forecast for the company.

BALANCE SHEET

End of year (in \) million)

Assets

Liabilities and Stockholder鈥檚 equity

Cash

\(25

Accounts payable

\)64

Accounts receivable

40

Accrued expenses

31

Inventory

82

Other payables

45

Plant and equipment

133

Common stock

50

Retained earnings

90

Total assets

\(280

Total liabilities and stockholder鈥檚 equity

\)280

All balance sheet items are expected to maintain the same percent-of-sales relationships as last year,* except for common stock and retained earnings. No change is scheduled in the number of common stock shares outstanding, and retained earnings will change as dictated by the profits and dividend policy of the firm. (Remember the net profit margin is 9 percent.)

b. What would be the need for external financing if the net profit margin went up to 10.5 percent and the dividend payout ratio was increased to 60 percent? Explain.

J. Lo鈥檚 Clothiers has forecast credit sales for the fourth quarter of the year:

September (actual)

\(70,000

Fourth Quarter

October

\)60,000

November

55,000

December

80,000

Experience has shown that 30 percent of sales are collected in the month of sale, 60 percent are collected in the following month, and 10 percent are never collected.

Prepare a schedule of cash receipts for J. Lo鈥檚 Clothiers covering the fourth quarter (October through December).

The Sterling Tire Company鈥檚 income statement for 20X1 is as follows:

STERLINE TIRE COMPANY

Income Statement

For the year ended December 31, 20X1

Sales (20,000 tires at \(60 each)

\)1,200,000

Less: variable costs (20,000 tires at \(30)

600,000

Less: fixed cost

400,000

Earnings before interest and taxes (EBIT)

\)200,000

Interest expenses

50,000

Earning before taxes (EBT)

\(150,000

Income tax expenses (30%)

45,000

Earning after taxe (EAT)

\)105,000

Given this income statement, compute the following:

a. Degree of operating leverage.

The Rogers Corporation has a gross profit of \(880,000 and \)360,000 in depreciation expense. The Evans Corporation also has \(880,000 in gross profit,

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Explain the difference in cash flow between the two firms.
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