Lamar Swimwear Solution

Chapter 03: Financial Analysis

Chapter 3

Financial Analysis

Discussion Questions

3-1.

If we divide users of ratios into short-term lenders, long-term lenders, and

stockholders, in which ratios would each group be most interested, and for what

reasons?

Short-term lenders–liquidity ratios because their concern is with the firm’s

ability to pay short-term obligations as they come due.

Long-term lenders–leverage ratios because they are concerned with the

relationship of debt to total assets. They also will examine profitability to insure

that interest payments can be made.

Stockholders–profitability ratios, with secondary consideration given to debt

utilization, liquidity, and other ratios. Since stockholders are the ultimate

owners of the firm, they are primarily concerned with profits or the return on

their investment.

3-1

Chapter 03: Financial Analysis

3-2.

Explain how the Du Pont system of analysis breaks down return on assets. Also

explain how it breaks down return on stockholders’ equity.

The Du Pont system of analysis breaks out the return on assets between the

profit margin and asset turnover.

Return on Assets

=

Net income

Total assets

Profit Margin



Net income

Sales

×



Asset Turnover

Sales

Total assets

In this fashion, we can assess the joint impact of profitability and asset turnover

on the overall return on assets. This is a particularly useful analysis because we

can determine the source of strength and weakness for a given firm. For example,

a company in the capital goods industry may have a high profit margin and a

low asset turnover, while a food processing firm may suffer from low profit

margins, but enjoy a rapid turnover of assets.

The modified form of the Du Pont formula shows:

Return on equity =

Return on assets  investment 

1  Debt/Assets 

This indicates that return on stockholders’ equity may be influenced by return

on assets, the debt-to-assets ratio or a...