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# Du Pont analysis

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On Page 797 of the Brealey textbook, Brealey discusses how the Dupont System links Return on Assets (ROA) and Return on Equity (ROE) ratios with other financial ratios in useful ways. Describe and explain some of the useful links developed by Dupont System for linking ROA and ROE with other financial ratios. Can you explain how the ratio "asset/equity" can be calculated? This is a graduate level discussion question and must be between 200-300 words.

#### Solution Preview

Return on Equity= Net Income/ Common Equity
Return on assets= Net Income/ Total Assets

Du Pont analysis is an extremely useful way of seeing how the various ratios determined a firm's profitability. The extended Du Pont equation is particularly useful:
ROE = Profit Margin x Total Assets Turnover x Equity Multiplier

= Net ...

#### Solution Summary

This provides the steps for Du Pont analysis

\$2.19

## Finance Calculation : DuPont (Du Pont) Analysis

DuPont Analysis. See attached file for full problem description.
The Fern Furniture Company, a manufacturer and wholesaler of high-quality home furnishings, has been experiencing low profitability in recent years. As a result, the board of directors has replaced the president of the firm with a new president, Helen Adams, who has asked you to make an analysis of the firm's financial position using the Du Pont chart. The most recent industry average ratios, and Fern's financial statements, are as follows:
INDUSTRY AVERAGE RATIOS
Current ratio 2x Sales/fixed assets 6x
Debtftotal assets 30% Sales/total assets 3X
Times-interest-earned 7x Profit margin on sates 3%
EBlTDAcoverage 9X Return ontotal assets 9%
Sales/inventory lox Return on common equity 12.9%
Days sales outstanding' 24 days
aCalculation is based on a 360-day year.
Fern Furniture Company: Balance Sheet as of December 31, 2001 (Millions of Dollars)
Cash \$ 45 Accounts payable \$ 45
Marketable securities 33 Notes payable 45
Net receivables 66 Other current liabilities 21
Inventories 159 Total current liabilities \$111
Total current assets \$303 Long-term debt 24
Total liabilities \$135
Gross fixed assets 225
Less depreciation 78 Common stock 114
Net fixed assets \$147 Retained earnings 201
Total stockholders' equity \$315
Total assets \$450 Total liabilities and equity \$450
Fern Furniture Company: Income Statement for Year Ended December 31, 2001 (Millions of Dollars)
Net sales \$795.0
Cost of goods sold 660.0
Gross profit \$ 135.0
Selling expenses 73.5
Depreciation expense 12.0
Earnings before interest and taxes \$ 49.5
Interest expense 4.5
Earnings before taxes (EBT) 45.0
Taxes (40%) 18.0
Net income \$ 270
a. Calculate those ratios that you think would be useful in this analysis.
b. Construct an extended Du Pont equation for Fern, and compare the company's ratios to the industry average ratios.
c. Do the balance sheet accounts or the income statement figures seem to be primarily responsible for the low profits?
41 'Which specific accounts seem to be most out of line in relation to other firms in the industry?
e. If Fern had a pronounced seasonal sales pattern, or if it grew rapidly during the year, how might that affect the validity of your ratio analysis? How might you correct for such potential problems?

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