Dupont method and ROIC

Book multinational business finance 10th edition by
David K Eiteman

Some example for Chapter 22 can be found at
www.aw.com/eiteman

use the following information for answering problems 1-4

Hong Kong tool company is a locally owned creator and distributor of mater tooling of all kinds Although the company designs and markets it does not manufacture itself. Instead most of the machine tools it sells are manufactured in China (across the boarder from HK in Guangdong Province) like most other major tool companies in the world. Although privately owned, the company had been trying to clean up its financial performance in the hops that the family can actually sell the company in the near future. The income statement and balance sheets for Hong Kong tool company that follow cover the most recent three year period.

Income statements for HK tool company (thousands of HK$)

Income items Year 1 Year2 Year 3
Sales revenues (net) 171,275 187,500 244,900
Cost of sales (cogs) (131,295) (143,810) (187,255)

Gross profit 39,980 43,690 57,675
Selling and admin expenses (27,800) (29,700) (36,765)
Operating profit (EBITDA) 12,180 13,990 20,910
Depreciation expenses (4,650) (4,800) (5,700)
Earnings before interest (EBIT) 7,530 9,190 15,210
Interest expenses (1,960) (2970) (6,125)
Earning before taxes (EBT)
5,570 6,220 9,085
Hong Kong corporate tax
(919) (1,026) (1,499)

Net income 4,651 5,194 7,586

Balance sheets for Hong tool company (thousands of HK$)

Assets Year 1
Year 2
Year 3

Cash and marketable securities 6,588
7,750
2,400

Accounts reciveable
22,475
24,800
33,325

Inventories 27,125 29,450 42,550
Pre paid expenses
387
925
1,163

Current assets
56,575
62,925
79,438

Net fixed assets 24,025 19,225 18,600
TOTAL ASSETS 80,600 82,150 98,038
LIABITIES AND NET WORTH
SHORT TEM DEBT 17,900 18,580 27,774
ACCOUNTS PAYABLE 14,610 15,500 19,850
Accrued expenses 3,100 3,705 5,108
Current liabilities
35,610
37,785
52,732

Long term debt
6,240
5,200
3,320

Owners equity 38,750 39,165 41,986
Total liabilities and net worth 80,600 82,150 98,038

1. Hong Kong tool company net work capital. A major initiative pursued by management at Hong Kong tool in the past three years has been to increase the effective ness of operations and financing by reducing the total invested capital in the business.
a. if HK tool defines total invested capital as the sum of cash, net working capital (NWC) and net fixed assets how had total invested capital changed over the pas three years?
b. Net working capital efficiency is also typically measured as the ration of sale to NWC. Is HK tool generating more sales per unit of (NWC) in year three than it did in year 1?

2. HK tool ROIC. Many firms use different financial performance metrics as indicators of performance and efficiency; HK tool prefers return on invested capital (ROIC) . if the company defines ROIC as the earning before interest and taxes (EBIT) divided by the total invested capital (cash plus net working capital plus net fixed assets) calculate HK tool ROIC over the past three years.

3. HK tool cash conversion cycle. HK tool is concerned that ii may not be actually increasing the efficiency of its cash conversion cycle, the basic components of the total net working capital being utilized by the company. Calculate the number of days of sales represented by each of the components of net working capital for the three year period. Which components of NWC seem to need additional managerial attention?

4. HK tool Dupont method. Similar to the evaluation employed in the ROIC analysis in problem 3 the management of HK tool wishes to evaluate the basic income statement and balance sheet components that are driving the company ROIC. Using the following traditional formulation of the basic Dupont method for financial analyses decompose the basic elements of HK tools three year performance.

EBIT X SALES = RETURN ON
SALES INVESTED CAPITAL INVESTED CAPITAL (ROIC)

5.