Chapter 14, Problem 1WM

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 return on assets directly (RDA = Operating profit/Total assets). and then confirm it by calculating RDA = Operating margin × Asset turnover.
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 return on equity (ROE = Net income/Equity) for each firm. For the two firms with the lowest ROEs. perform a DuPont analysis to isolate the source(s) of the problem.

Summary Introduction

(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

Conclusion

Thus, Operating Profit Margin & Assets Turnover Ration computed as above

Summary Introduction

(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

1^stFormula 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

2^ndFormula 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

Conclusion

Thus, from the above computation, it can be seen that Return on Assets computed by both formula is same.

Summary Introduction

(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.

Conclusion

All the compared companies belongs to different industries and hence investors can take decision based on the explanation as above.

Summary Introduction

(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%.

The reason for the same is inefficient utilization of its assets to generate revenue& also not generation of sufficient operating margin out of revenues generated. Since, Asset Turnover is directly related to generation of revenue to the use of its assets which is turn is relatable to generation of operating profit, hence both Assets Turnover Ratio& Operating Profit Margincan be said to be the reason behind low ROAs.

ROA can be improved by reducing the Asset Cost, increasing turnover, increasing operating margin etc.

Conclusion

ROA can be improved by reducing the Asset Cost, increasing turnover, increasing operating margin etc.

Summary Introduction

(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

Conclusion

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.