Week 3 - Financial Forecasting & Analysis

Question 1

Du Pont Identity

what is it

Answer 1

• provides deeper insight in how a company generates return on equity (ROE)
• decompose ROE into its component factors

Question 2

Using the Du Pont Identity

Answer 2

ROE = PM x TAT x EM
- profit margin is a measure of the firm’s operating efficiency – how well it controls costs
- total asset turnover = measure of the firm’s asset use efficiency - how well it manages its assets
- equity multiplier is ameasure of the firm’s financial leverage

Question 3

Basic Elements of Financial Planning

Answer 3

• investment in new assets (capital budgeting decisions)
• degree of financial leverage (capital structure decisions)
• cash paid to shareholders (dividend policy decisions)
• liquidity requirements (net working capital decisions)

Question 4

Forecasting Model

pro forma

Answer 4

• make a sales revenue forecast
• make assumptions about how expenses change
• calculate forecasted net income
• decide dividend policy
• basically all about assumptions

Question 5

Percentage of Sales Method

Answer 5

• provides default assumptions about how certain accounts are expected to change, based on assumptions of
  1. constant profit margin
  2. constant total asset turnover

Question 6

Limitations in the context of DuPont

Answer 6

• what about short term fluctuations?
• what other ratios are behind the scenes?
• does it make sense that all assets increase at the same rate as sales?