case study 3

i have a study case for accounting. where we have to answer some questions.

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Rev. Nov. 2, 2018
The Financial Cockpit: Three Levers and One Flight Plan
Jill Keyes, a nonfinancial product specialist at Craftsman Furniture, Inc. (CFI), was interested in selecting
a handful of financial ratios that would enable her to quickly and insightfully highlight some of the
fundamental differences among companies’ financial results. She was wondering how CFI compared with
other companies, and she was also interested in some initial financial screening that she could use to identify a
handful of small, healthy companies with which CFI might want to partner in the future. Moreover, if the few
select ratios she settled on also pointed to some of the fundamental differences among companies’ business
models, that would be even better. At that moment, she did not have the time to undertake an extensive,
data-intensive statistical-modeling research study—she just wanted some basic insights that she could easily
access and use to compare and contrast how companies generated returns for their shareholders.
She recalled from her college days learning about the DuPont financial ratios model in an introductory
business course. She wondered if she could find her course notes and if those DuPont ratios would provide
the succinct, provocative insights she was after. And wouldn’t it be great if yearly amounts for those ratios
were publicly available across a spectrum of companies?
Resurrecting the DuPont Model Ratios
That weekend, Keyes dug through a dusty box of college course binders she had miraculously saved for
just such an occasion. Near the bottom of the box, she found a binder with “Introduction to Business”
scribbled on the front of it. The binder was not nearly as thick as those she had saved from her European
history major days, but she was once again thankful that she had heeded her father’s advice to take a couple
business courses.
As she opened the binder, she did come across several pages with “DuPont” written at the top. Eureka!
Thank goodness she had saved her notes—they were bound to save her a lot of time deciding if the DuPont
model provided the insights and ease of use she was looking for.
As she slowly read the pages, memories of the conversations, the professor, the classroom, and even
whom she was dating at the time all came back to her. Jeremy Nobis had helped her through the course, and
that had been no small feat. She had to admit those tutoring sessions had not been very helpful because she
had fallen head over heels for Nobis, and his business tutorial was often a distraction. But as she reread her
notes, she was amazed at how much she did recall and how much of it still made sense.
Several points seemed to jump out at her. At the very top of the first page of the DuPont notes, she had
written, “Shareholders want increasing and ever more predictable returns from the investments they make.”
In addition, she had written in the margin, “Return on equity (ROE) is an important measure of how well a
This case was prepared by Professor Mark Haskins. It was written as a basis for class discussion rather than to illustrate effective or ineffective
handling of an administrative situation. Copyright  2010 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights
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company has employed owners’ funds.” And last, there was a diagram on a subsequent page (like the one
reproduced below in Figure 1) with the notation, “The CEO has only three levers in the cockpit to fly the
plane called ABC Inc.”:
Figure 1. Desired ROE trajectory, over time, for the plane called ABC Inc.
ROE
Time
Source: Created by author.
Near the bottom of that diagram she had written
ROS × Asset Turnover × Financial Leverage = ROE.
(1)
From this Equation 1, and with a bit of affirmation from the recesses of her memory, she figured the
three metrics in that equation must be the “three levers” available to a CEO for elevating, accelerating,
redirecting, and/or holding company performance steady—all with the aim to create ever better, ever more
predictable ROE for shareholders.
Context for Keyes’s Task
Located in the southeastern region of the United States, CFI was a medium-size manufacturer and
distributor of household and office furniture. Over the years, the company’s sales had grown modestly, as a
robust business economy and rising household incomes had undergirded a steady desire for high-quality,
classic residential furniture. The company was one of the few furniture companies founded in the United
States that had not either gone out of business or migrated to offshore sites during the previous two decades.
Keyes and her colleagues were convinced, however, that they had to solidify the company’s market
position through some key joint ventures, partnerships, or even some small niche corporate acquisitions.
Certainly, they had to consider the basic financial position of any potential affiliate. This was especially true if
an acquisition possibility were in play—it would not be good for an acquisition to create a significant dilutive
effect on any of CFI’s fundamental financial performance metrics such as those comprising the DuPont
model.
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Financial Focus
As Keyes reviewed the rest of her well-preserved “Introduction to Business” college course notes, she
became more and more comfortable with the thought that the DuPont model provided a widely accepted,
very useful financial yardstick by which to evaluate a company’s overall financial performance. She also began
to see how, over time, it could actually reveal something about the operational philosophy and capability of a
company.
With CFI’s latest annual report in hand, she calculated the five DuPont ratios, using the following
formulas:
Return on Sales (ROS) = Net Income (NI) ÷ Sales,
Asset Turnover = Sales ÷ Average Total Assets (TA),
Return on Assets (ROA) = NI ÷ Average TA,
Financial Leverage = Average TA ÷ Average Owners’ Equity (OE), and
Return on Equity (ROE) = NI ÷ Average OE.
She saw that ROA was merely the product of ROS multiplied by asset turnover, and therefore it was
redundant in deriving the ROE figure. Thus the latest ROE results for CFI were as follows:
ROS × Asset Turnover × Financial Leverage = ROE;
3% × 1.67 × 2.6 = 13%.
As she sat back and began to think about how best to interpret these metrics and their values for CFI,
she realized she needed some sort of comparative baseline. So she booted up her laptop and downloaded the
annual reports for several well-known companies.
As her stomach began to growl, suddenly signaling to her that it was well past lunchtime, she took a
break. She might as well grab a bite to eat and then finish her DuPont task. She felt a sense of satisfaction for
a morning’s worth of work well done, even if it was a Saturday morning. She had calculated two years of
DuPont ratios for each of the nine companies she had selected (see the summary shown in Exhibit 1). She
took a glance outside and saw that it was raining. With a bit of enthusiasm that surprised her, and with a bit
of discipline that typified her approach to most tasks, and while the DuPont context was fresh in her mind,
she jotted down the questions she wanted to pursue after lunch:

Which of the nine companies used its assets most productively?

Which of the companies used debt most aggressively in financing its operations?

Which company’s ROE would be the most attractive to investors, and how was it generated?

Which company changed the most in how it generated ROE results for investors from Year 1 to
Year 5? Explain.

Did any of the companies change for the worse in how it generated ROE results for investors from
Year 1 to Year 5? Explain.
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
What were the ratio amounts, for the same nine companies in years subsequent to Year 5, and what
insights did those additional data offer?

Were there other companies that should be reviewed to help evaluate CFI more fully and to help
grasp the varied way(s) other companies generated ROE results for their investors?

What other data and sources of information would be important to tap into in order to more fully
flesh out the story depicted by these DuPont ratio amounts and trends?
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Exhibit 1
The Financial Cockpit: Three Levers and One Flight Plan
Selected DuPont Ratio Amounts*
Computers and Office Equipment Industry Category
Year
ROS %
Asset Turnover
ROA %
Year 5
Year 1
7
4
1.00
1.25
7
5
Financial
Leverage
3.00
1.80
Dell
Year 5
Year 1
4
6
2.25
2.17
9
13
6.44
3.62
58
47
Apple
Year 5
Year 1
15
3
0.80
1.00
12
3
1.92
1.67
23
5
Company
HewlettPackard
ROE %
21
9
Household and Personal Products Industry Category
Procter &
Gamble
KimberlyClark
Estée
Lauder
Year 5
Year 1
14
13
0.57
0.85
8
11
2.13
3.45
17
38
Year 5
Year 1
9
12
1.00
0.92
9
11
4.89
2.45
44
27
Year 5
Year 1
6
6
1.50
1.50
9
9
3.22
2.22
29
20
Internet Services and Retailing Industry Category
Google
Year 5
Year 1
19
13
0.68
0.92
13
12
1.15
1.17
15
14
Year 5
Year 1
6
23
0.50
0.39
3
1.33
4
Yahoo!
9
1.33
12
eBay
Year 5
Year 1
21
24
0.52
0.42
11
10
1.45
1.20
16
12
*Note: The Year 5 ROS, ROA, and ROE amounts are from Fortune, May 4, 2009; the Year 1 amounts for the same three ratios are
from Fortune, April 18, 2005. The amounts for asset turnover and financial leverage are interpolated by the author from the other
three ratios in the table.
This document is authorized for use only by Danai Nyaungwa in TGM 517 Global Accounting (MGM SP24) taught by Aneel Iqbal, Arizona State University from Jan 2024 to Feb 2024.