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Ratio Analysis DuPont System Effects of Improving Ratios Limitations of Ratio Analysis Qualitative Factors
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$1,985,827
380,510 67,413
$1,840,991
317,503 54,045
$313,097
$2,298,924
$263,458
$2,104,449
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Long-term debt
Common stock (100,000 shares) Retained earnings Total equity Total liabilities and equity
656,600
550,000 19,132 $569,132 $2,298,924
410,769
550,000 111,816 $661,816 $2,104,449
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Income Statement
Sales Cost of goods sold Other expenses Total operating costs excluding depreciation and amortization Depreciation and amortization EBIT Interest expense EBT Taxes (40%) Net income 2009(E) $2,069,032 1,647,925 241,490 $1,889,415 17,891 $161,726 27,434 $134,292 53,717 $80,575 2008 $2,325,967 1,869,326 287,663 $2,156,989 25,363 $143,615 31,422 $112,193 44,877 $67,316
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Other Data
2009(E) EPS DPS Book value per share $0.81 $1.00 $5.69 2008 $0.67 $1.00 $6.62
Stock price
Share outstanding Tax rate
$19.20
100,000 40%
$15.60
100,000 40%
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Ratios standardize numbers and facilitate comparisons. Ratios are used to highlight weaknesses and strengths. Ratio comparisons should be made through time and with competitors.
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Liquidity: Can we make required payments? Asset management: right amount of assets vs. sales? Debt management: Right mix of debt and equity? Profitability: Do sales prices exceed unit costs, and are sales high enough as reflected in PM, ROE, and ROA? Market value: Do investors like what they see as reflected in P/E and M/B ratios?
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Expected to improve but still below the industry average. Liquidity position is weak.
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Everelites Inventory Turnover vs. the Industry Average Inventory turnover09 = Sales/Inventory = $2,069/$909 = 2.28
2009E Inventory turnover 2.28x 2008 2007 Ind.
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Inventory turnover is below industry average. Everelite might have old inventory, or its control might be poor. No improvement is currently forecasted.
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DSO: Average Number of Days after Making a Sale before Receiving Cash
DSO = Receivables/Avg. sales per day = Receivables/(Annual sales/365) = $876/($2,069/365) = 154.69 days
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Appraisal of DSO
2009E DSO 2008 2007 Ind.
154.69x 108.32x
135.60x
56
Everelite collects on sales too slowly, and is getting worse. Everelite has a poor credit policy.
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Fixed Assets and Total Assets Turnover Ratios vs. the Industry Average
FA turnover = Sales/Net fixed assets = $2,069/$313 = 6.61
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FA turnover projected to be still below the industry average. TA turnover below the industry average. Caused by excessive currents assets (A/R and Inv).
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D/A TIE
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Profitability Ratios: Operating Margin, Profit Margin, and Basic Earning Power
Operating margin09= EBIT/Sales = $161.7/$2,069 =7.82%. Profit margin09= Net income/Sales = $80.5/$2,069 = 3.89%. Basic earning power09=EBIT/Total assets = $161.7/$2,299 = 7.03%.
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Appraising Profitability with Operating Margin, Profit Margin, and Basic Earning Power
2009E 2008 2007 Ind. 7.82% 6.17% 11.91% 13% 3.89% 2.89% 6.78% 9.00% 7.03% 6.82% 14.38% 15.00%
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Appraising Profitability with Operating Margin, Profit Margin, and Basic Earning Power
Operating margin was very bad in 2008. It is projected to improve in 2009, but it is still projected to remain below the industry average. Profit margin was very bad in 2008. It is projected to improve in 2009, but it is still projected to remain below the industry average. BEP removes the effects of taxes and financial leverage, and is useful for comparison. BEP projected to improve, yet still below the industry average. There is definitely room for improvement.
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Both ratios rebounded from the previous year, but are still below the industry average. More improvement is needed. Wide variations in ROE illustrate the effect that leverage can have on profitability.
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ROA is lowered by debt interest lowers NI, which also lowers ROA = NI/Assets. But use of debt also lowers equity, hence debt could raise ROE = NI/Equity.
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ROE and shareholder wealth are correlated, but problems can arise when ROE is the sole measure of performance.
ROE does not consider risk. ROE does not consider the amount of capital
invested. decisions that do not benefit shareholders.
ROE focuses only on return and a better measure would consider risk and return.
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P/E M/B
P/E: How much investors are willing to pay for $1 of earnings. M/B: How much investors are willing to pay for $1 of book value equity. For each ratio, the higher the number, the better. P/E and M/B are high if ROE is high and risk is low.
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Focuses on expense control (PM), asset utilization (TA TO), and debt utilization (equity multiplier).
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How would reducing the firms DSO to 56 days affect the company?
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Repurchase stock Expand business Reduce debt All these actions would likely improve the stock price.
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Comparison with industry averages is difficult for a conglomerate firm that operates in many different divisions. Average performance is not necessarily good, perhaps the firm should aim higher. Seasonal factors can distort ratios. Window dressing techniques can make statements and ratios look better.
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Different operating and accounting practices can distort comparisons. Sometimes it is hard to tell if a ratio is good or bad. Difficult to tell whether a company is, on balance, in strong or weak position.
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Are the firms revenues tied to one key customer, product, or supplier? What percentage of the firms business is generated overseas? The firms competitive environment Future prospects Legal and regulatory environment
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