Playing the numbers game

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Please see the attached files. The excel file has the calculations.

Case 3: DuPont Analysis: Playing the Numbers Game!

"Numbers! I need to see numbers!" exclaimed Andrew in response to comments made by the assistant vice-president of Finance, Jack Brown. Andrew Sullivan, the President and Chief Executive Officer of Plastichem Inc., had been instrumental in significantly increasing the company's size during his first five years in office. He spearheaded some successful marketing campaigns and revamped the production facilities by adopting the latest technology in injection molding. He also implemented various cost-cutting measures and introduced performance plans to boost efficiency. Foremen and supervisors were offered stock option incentives, and bonuses were tied to earnings per share (EPS) growth.

Plastichem Inc., a medium-sized plastic molding company, was founded in 1990 and was located in Midland, Michigan. The company supplied molded plastic products to various processing industries as well as end-users. It enjoyed a fairly diversified base of customers ranging from automobile and home products manufacturers to the federal government. After an initial period of sluggish growth, the firm's revenues and profits had almost quadrupled. Most of the increase had been achieved under the leadership of Andrew Sullivan. The plastics business offered potential for high profit margins and as a result it attracted many competitors. Despite the fierce competition, Plastichem's stock, which traded in the over-the-counter market, had tripled in value over the past five years making the shareholders very happy.
Recently, however, the stock price had dipped sharply, raising concerns among security analysts. Jack Brown, the assistant VP of Finance, brought this matter to Andrew's attention informing him that the analysts had given their closest rival, DCM Molding, a "Strong Buy" rating while downgrading Plastichem's rating to a "Hold." This recent development had outraged shareholders and the Personal Relations department had been overwhelmed with calls from anxious owners wanting to know what was going on.
Andrew, a motivated leader, was not about to give up easily, however. His track record of turning companies around was very good. He knew that if he could identify the main problem areas, he would be able to make some strategic moves to alleviate the problems. He, therefore, demanded that he be given a detailed report of the firm's financial condition in comparison to that of DCM Molding. Andrew had learned over the years that in order to be successful it was very important to "play the numbers game."
Questions:
1. Jack Brown realizes that the first thing he must do is compare the liquidity, leverage, activity, and profitability ratios of the two companies. Using the income statement and balance sheet data shown in Tables 1-4 prepare a detailed comparison report indicating the strengths and weaknesses of each company.
Plastichem - Ratio Analysis DCM Ratio Analysis
2004 2003 2002 2001 2004 2003 2002 2001
Current Ratio 1.30 1.52 1.46 1.31 1.63 1.52 1.83 2.09
Quick Ratio 0.86 1.14 1.04 0.83 0.99 0.93 1.11 1.57
Cash Ratio 0.05 0.08 0.08 0.02 0.01 0.06 0.02 0.39
Total Debt Ratio 1.05 0.84 0.83 0.58 0.54 0.60 0.56 0.42
Debt-Equity Ratio -19.12 5.02 4.86 1.36 1.12 1.35 1.14 0.61
Equity Multiplier -18.33 6.08 5.86 2.36 2.19 2.48 2.28 1.71
Times Interest Ratio 0.76 1.91 1.96 2.44 4.67 5.61 5.39 8.60
Cash Coverage Ratio 1.58 2.71 2.90 3.54 6.57 7.65 7.44 12.80
Inventory Turnover ratio 8.11 7.66 6.32 6.57 6.40 5.91 5.90 6.97
Day's sales in Inventory 45.01 47.68 57.72 55.55 57.00 61.71 61.82 52.33
Receivables Turnover 6.44 4.93 5.04 6.19 6.91 6.63 6.59 6.17
ACP or Days' Sales in Receivables 56.65 73.99 72.45 59.00 52.86 55.07 55.37 59.14
Total Asset Turnover 1.12 0.85 0.74 1.30 1.37 1.22 1.34 1.20
Capital Intensity 0.89 1.17 1.35 0.77 0.73 0.82 0.75 0.83
Profit Margin -24.07% 0.68% 1.47% 5.65% 5.91% 6.19% 5.72% 5.32%
ROA -26.90% 0.58% 1.09% 7.34% 8.10% 7.53% 7.66% 6.39%
ROE NMF 3.53% 6.38% 17.30% 17.76% 18.64% 17.44% 10.95%
The liquidity of the two companies can be assesses through the current ratio and quick ratio. If we look at the current ratio, it has been falling for both the companies, but DCM molding is higher than Plastichem. The quick ratio for DCM is also higher than Plastichem as of 2001. This indicates that DCM has a better short term liquidity situation then Plastichem. The current ratio for both is above 1, indicating more current assets as compared to current liabilities, the ratio is falling and so the liquidity is decreasing but DCM is better.

For leverage ratios we use the Total debt Ratio and the times interest ratio. Total debt ratio gives the proportion of debt financing in total financing and times interest ratio indicates the cushion that a firm has in meeting interest payments. For Plastichem, the total debt ratio is increasing indicating that more debt is being used as compared to equity and in 2001, the ratio is above 1 since the total equity is negative. As the level of debt has gone up, the times interest ratio has fallen as is 0.76 in 2001 indicating that the earnings are not sufficient to pay for debt. In contrast for DCM, the debt ratio in 2001 is only 0.54 and the times interest earned is 6.57, indicating comparatively less use of debt and more cushion in making the interest payments. The financial risk to DCM is much less as compared to Plastichem.

For activity ratios we look at the various turnover ratios which measure the efficiency in use of assets. Plastichem is better than ...