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DuPont formula, analyze common size income statement

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Solution Summary

This solution is comprised of detailed explanation and step-by-step calculation of the following questions:

(1) The DuPont formula defines the net return on shareholder's equity as a function of operating margin, asset turnover, interest burden, financial leverage, and income tax.
Using data from the financial reports of Southwest Airlines, Caterpillar, and Proctor and Gamble calculate the return on equity using the DuPont ratio for years ending 2005-2007 (show all work).
Briefly discuss the impact of the changes in asset turnover and financial leverage on ROE over the the three years. (2.5 points)

(2) Select an industry of your choice from the list below. Evaluate the industry in terms of the five factorst hat determine an industry's intensity of competition.
Based on your analysis what are your expectations about the industry's profitability in the short run (1-2 years) and the long run (5-10 years)?
The response does not have to include assesments of the specific rates of return; this is more of a qualitative exercise. (3 points)

The industries are (as defined by the S&P 500):
Consumer discretiionary
Consumer staples
Health Care
Information Technology

(3) Select two stocks in an industry of your choice and perform a common size income statement analysis over a two-year period.
Discuss which firm is more cost-effective.
Discuss the relative year-to-year changes in gross profit margin, operating profit margin, and net profit margin for each company. (2.5 points)
A list of references is also provided.