Go to finance.yahoo.com to find information about Vulcan Materials Company (VMC). Southwest Airlines (LUV). Honda Motor Company (HMC), Nordstrom). Inc. (JWN), and Abbott Laboratories (ABT). Download the most recent income statement and balance sheet for each company.
a. Calculate the Operating profit margin (operating profit/sales) and the asset turnover (sales/assets) for each firm.
b. Calculate the
c. In what industries do these firms operate? Do the ratios make sense when you consider the industry types?
d. For the firms that have relatively low ROAs, does the source of the problem seem to the operating profit margin, the asset turnover, or both?
e. Calculate the
(A)
Adequate information:
Information derived from finance.yahoo.com as per latest Financials available
To Compute:
Operating Profit Margin and the Asset Turnover Ratio
Introduction:
Operating Profit Margin is the measure of profitability. It determines the profit available to a Company after incurring operating cost for the Company.
Asset Turnover Ratio measures the ability of the company to generate sales Formula for Asset Turnover Ratio= Sales /Assets
Explanation of Solution
Formula for Operating Margin is = Operating Profit/ Sales
Company | |||||
Particulars | Vulcan Materials Company | Southwest Airlines Co. (LUV) | Honda Motor Company | Abbott Laboratories | Nordstrom, Inc. (JWN) |
Operating Profit(in 000s) | 645,297.00 | 3,455,000.00 | 887,297,000.00 | 2,940,000.00 | 926,000.00 |
Sales(in 000s) | 3,890,296.00 | 21,171,000.00 | 15,361,146,000.00 | 27,390,000.00 | 15,478,000.00 |
Operating Profit Margin | 16.59 | 16.32 | 5.78 | 10.73 | 5.98 |
Formula for Asset Turnover Ratio= Sales /Assets
Particulars | Company | ||||
Vulcan Materials Company | Southwest Airlines Co. (LUV) | Honda Motor Company | Abbott Laboratories | Nordstrom, Inc. (JWN) | |
Sales(in 000s) | 3,890,296.00 | 21,171,000.00 | 15,361,146,000.00 | 27,390,000.00 | 15,478,000.00 |
Assets(in 000s) | 9,444,111.00 | 25,110,000.00 | 19,349,164,000.00 | 76,250,000.00 | 8,115,000.00 |
Asset Turnover Ratio | 0.41 | 0.84 | 0.79 | 0.36 | 1.91 |
Thus, Operating Profit Margin & Assets Turnover Ration computed as above
(B)
Introduction:
Return on Assets (ROA) is an indicator of how efficiently the resources of the Company has been utilised i.e. measure of profitability based on its total assets.
Explanation of Solution
1stFormula for computation of ROA = Operating Profit /Total Assets
Particulars | Company | |||||
Vulcan Materials Company | Southwest Airlines Co. (LUV) | Honda Motor Company | Abbott Laboratories | Nordstrom, Inc. (JWN) | ||
Operating Profit
(in 000s) |
645,297.00 | 3,455,000.00 | 887,297,000.00 | 2,940,000.00 | 926,000.00 | |
Assets
(in 000s) |
9,444,111.00 | 25,110,000.00 | 19,349,164,000.00 | 76,250,000.00 | 8,115,000.00 | |
ROA | 6.83 | 13.76 | 4.59 | 3.86 | 11.41 |
2ndFormula for computation of ROA = Operating Margin * Asset Turnover
Particulars | Company | |||||
Vulcan Materials Company | Southwest Airlines Co. (LUV) | Honda Motor Company | Abbott Laboratories | Nordstrom, Inc. (JWN) | ||
Operating Margin | 16.59 | 16.32 | 5.78 | 10.73 | 5.98 | |
Asset Turnover | 0.41 | 0.84 | 0.79 | 0.36 | 1.91 | |
ROA | 6.83 | 13.76 | 4.59 | 3.86 | 11.41 |
Thus, from the above computation, it can be seen that Return on Assets computed by both formula is same.
(C)
To Compute:
Nature of Industries in which different companies operate. Whether the Ratios make sense when different industry types are considered.
Introduction:
Investors can use different ratios to compare stability, efficiency, profitability of different companies and make investment thereon. Such ratios are comparable when comparing companies in same industry. Ratios can also be used to determine the industry type which is best for investment, assuming that companies compared from different industry is the benchmark for other companies in same industry.
Explanation of Solution
Particulars | Company | ||||
Vulcan Materials Company | Southwest Airlines Co. (LUV) | Honda Motor Company | Abbott Laboratories | Nordstrom, Inc. (JWN) | |
Nature of Industry | Building Materials | Airlines | Auto Manufacturers | Medical Devices | Department Stores |
Since Computed Ratios are for different sectors and industries, the same is not comparable, hence is not of much sense to the investors. However, if comparison is made based industry wise, an investor can go for investment in Industries for which ratios are most favorable, assuming that companies compared from different industry sets the benchmark for other companies in same industry.
All the compared companies belongs to different industries and hence investors can take decision based on the explanation as above.
(D)
To Compute:
Identification of problems for Firms that have relatively low ROAs, whether it is Operating Profit Margin or the asset turnover ratio or both
Introduction:
Return on Assets is an indication of profitability of the Company by making efficient use of its Assets. A higher ROA is good for company which signifies that the company is making good profit by making use of its resources. Generally, ROA over 5% are considered good.
A low percentage return on assets indicates that the company is not making enough income from the use of its assets.
Explanation of Solution
- In the present case, Abbott Laboratories & Honda Motor Company has ROA less than 5%.
ROA can be improved by reducing the Asset Cost, increasing turnover, increasing operating margin etc.
(E)
To Compute:
Return on Equity (ROE = Net Income/Equity) for each firm and perform DuPont analysis for firms which has lowest ROEs.
Introduction:
In simple terms, Return on Equity is the determination of profitability of a company in relation to stockholder's equity..
Explanation of Solution
Formula for computation of Return on Equity = Net Income /Equity
Particulars | Company | ||||
Vulcan Materials Company | Southwest Airlines Co. (LUV) | Honda Motor Company | Abbott Laboratories | Nordstrom, Inc. (JWN) | |
Net Income | 601,185.00 | 3,488,000.00 | 1,059,337,000.00 | 468,000.00 | 437,000.00 |
Equity | 4,968,893.00 | 10,430,000.00 | 7,933,538,000.00 | 30,897,000.00 | 977,000.00 |
ROE | 0.12 | 0.33 | 0.13 | 0.02 | 0.45 |
Abbott Laboratories & Vulcan Materials Company has lowest ROE as per above calculation. Three Step DuPont Calculation is performed as below:
Three Step DuPont Calculation
There are three components for DuPont calculation which include Operating efficiency, Assets use efficiency & Financial Leverage. Operating efficiency is measured by profit margin, Assets use efficiency is measured by total asset turnover & financial leverage by the equity multiplier.
Thus, ROE is broken up into 3 components as= (net profit margin) * (asset turnover) * (equity multiplier)
Particulars | Vulcan Materials Company | Abbott Laboratories |
Net Income | 601,185.00 | 468,000.00 |
Sales | 3,890,296.00 | 27,390,000.00 |
Equity | 4,968,893.00 | 30,897,000.00 |
Assets | 9,444,111.00 | 76,250,000.00 |
Net Profit Margin (Net Income/Sales) | 0.15 | 0.02 |
Asset Turnover (Sales/Assets) | 0.41 | 0.36 |
Equity Multiplier (assets / shareholders' equity) | 1.90 | 2.47 |
ROE | 0.12 | 0.02 |
In case of Abbott and Vulcan Materials, Net Income to Sales is less, hence appears to be main reason for low ROE and also the inability of the companies to generate sufficient sales out of resources used.
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Chapter 14 Solutions
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