The DuPont analysis stresses that ROA is affected by 3 factors:

High profit margins

Rapid turnover of assets
Use of debt

ROA = Net Income Sales

x
Sales Total Assets

Therefore, higher Net income (or high profit margins) = higher ROA

ROA = PM x AASSET TURNOVER

PM = Net Income / Sales

THEREFORE HIGHER SALES = HIGHER PM AND HIGHER ROA

Also, higher Asset Turnover increases ROA

ROE = ROA x Equity Multiplier

EM = Total Assets / Equity, so a higher Total Assets = higher EM and a higher ROE.
Chapter 3
Problem 3.22

THE SPORTS CAR TIRE COMPANY

Income Statement
Sales 20,000
Less: Cost of Goods Sold 9,000
Gross Profit 11,000
Less: Selling and Administrative Expense 4,000
Less: Lease Expense 1,000
Operating Profit* 6,000
Less: Interest Expense 500
Earnings Before Taxes 5,500
Less: Taxes (40%) 2,200
Earnings After Taxes 3,300

*Operating Profit also known as Earnings Before Interest and Taxes (EBIT)

Additional Information:
Total Assets = 40,000

a. Interest Coverage
Interest Coverage = EBIT/Interest

Interest Coverage = 12 This ratio tells us that earnings are 12 tim

(Note: Interest Coverage Ratio also known as "Times Interest Earned") interest expense, or earnings could dimin
current level and still cover interest obliga
b. Fixed Charge Coverage
Fixed Charge Coverage = Income before fixed charges and taxes/Fixed charges
Fixed Charge Coverage = (EBIT + Lease Expense)/(Interest Expense + Lease Expense)

Fixed Charge Coverage = 4.67 This ratio tells us that "earnings" are more
4.67 times greater than fixed obligations,
Set model for DuPont system and proceed could diminish to 21% of the current leve
these obligations.
ROA = PM x TATO = NI/S x S/A

ROE = ROA x EM = NI/A x A/E = PM x TATO x EM = NI/S x S/A x A/E

c. Profit Margin = NI/S

PM = 0.17 Each dollar of sales produces BLANK cent

or 16.50% (percent)
d. Total Asset Turnover = S/A

TATO = 50.0% Each dollar of assets produces BLANK cen

e. Return on Assets = Profit Margin x Total Asset Turnover

ROA = PM x TATO =

ROA = 0.08 Each dollar of assets produces BLANK cen

or 8.25% (percent) This company has a relatively high profit m
As a check, ROA also = NI/A is relatively capital intensive. It takes cons
capital to produce sales, but sales are pro
ROA = 0.0825
or 8.25% (percent)
 tells us that earnings are 12 times larger than
xpense, or earnings could diminish to 12 times less than the
vel and still cover interest obligations.

tells us that "earnings" are more than

s greater than fixed obligations, or earnings
minish to 21% of the current level and still cover

ar of sales produces BLANK cents of earnings

ar of assets produces BLANK cents of sales

ar of assets produces BLANK cents of earnings.

pany has a relatively high profit margin and
ly capital intensive. It takes considerable
produce sales, but sales are profitable.