1. Value Drivers Discussion
Dr. Steve Byers

2. Objectives Be familiar with the DuPont system
History
Basics
Interpretation
Extensions
Conduct a Financial Analysis of a Real Company in Real Time
Procter & Gamble
Conduct a financial analysis using Excel

3. The DuPont Equation
History
Éleuthère Irénée du Pont
1802

4. Gunpowder

5. Lots of famous inventions:
Lycra
Teflon
Kevlar
Freon
Lucite
Nylon
…… and Return on Investment

6. Donaldson Brown DuPont explosives salesman 1912 internal report
General Motors under Alfred Sloan

7. Basic form of the DuPont equation:

8. ( )( )( ) = ROE The DuPont Equation Profit margin TA turnover Equity
multiplier NI
Sales
Sales TA TA CE
= ROE x x
Note that the first two terms are equivalent to ROA.

9. ( )( )( ) = ROE The DuPont Equation Profit margin TA turnover Equity
multiplier NI
Sales
Sales TA TA CE
= ROE x x
DuPont Analysis examines:
Firm’s profitability (measured by ROA)
Firm’s expense control (measured by profit margin)
Firm’s asset utilization (measured by total asset turnover)
Debt management (measured by the Equity Multiplier)

10. Return on Assets
Before we look at the whole model, let’s look at the first piece: ROA
ROA = Net Profit Margin X Total Assets Turnover
Net Income
Sales
Total Assets X =

11. Let’s compare the ROA for firms in two very different industries: Jewelry and Groceries

12. Let’s compare the ROA for firms in two very different industries: Jewelry and Groceries
Company
ROA =
Profit Margin x
Asset Turnover
Tiffany & Co.
9.04%
11.30%
0.80
Kroger Co.
6.02%
1.86%
3.24

13. ROE = How does Leverage work?
Suppose we have an all equity-financed firm worth $100,000. Its earnings this year total $15,000. (we will ignore taxes).
ROE =

14. ROE = = 15% 15,000 100,000 How does Leverage work?
Suppose we have an all equity-financed firm worth $100,000. Its earnings this year total $15,000.
ROE = = 15%
15,000
100,000

15. ROE = How does Leverage work?
Suppose the same $100,000 firm is financed with half equity, and half 8% debt (bonds). Earnings are still $15,000.
ROE =

16. ROE = = 15,000 - 4,000 50,000 How does Leverage work?
Suppose the same $100,000 firm is financed with half equity, and half 8% debt (bonds). Earnings are still $15,000.
ROE = =
15, ,000
50,000

17. ROE = = 22% 15,000 - 4,000 50,000 How does Leverage work?
Suppose the same $100,000 firm is financed with half equity, and half 8% debt (bonds). Earnings are still $15,000.
ROE = = %
15, ,000
50,000

18. Effect of Leverage
Positive Leverage: If ROA > Interest Rate, then ROE will get a “boost” – it will be higher than if there wasn’t leverage
Negative Leverage: If ROA < Interest Rate, then ROE will be hurt – it will be lower than if there wasn’t leverage
Financial Leverage magnifies the effects of the operating performance (the ROA). It also adds risk to the company.

19. Now let’s look at the ROE for our two firms
Now let’s look at the ROE for our two firms. But first let’s review the overall DuPont equation:

20. ( )( )( ) = ROE The DuPont Equation Profit margin TA turnover Equity
multiplier NI
Sales
Sales TA TA CE
= ROE x x
Remember that the first two terms are equivalent to ROA. Now let’s look at the ROE for our firms.

21. ROE = ROE for our two firms: Company Profit Margin x Asset Turnover
Equity Multiplier
Tiffany & Co.
9.04%
11.30%
0.80
1.76
Kroger Co.
6.02%
1.86%
3.24
4.97

22. Leverage Measures
There are 3 basic leverage ratios that provide the same information.
Debt Ratio = Debt/Assets
Debt Equity Ratio = Debt/Equity
Equity Multiplier = Assets/Equity
Here’s how to convert between them:
Debt
Assets
Equity

23. Adjusting DuPont Analysis
Extended DuPont Analysis
Looks more closely at how net income is determined
Effects of financing (interest burden)
Effects of taxes (tax burden)
Important Driver – Operating Profit Margin

24. Extended DuPont Analysis

25. Extended DuPont Analysis
OPM – Operating Profit Margin: EBIT more clearly measures operational efficiency.
IB – Interest Burden: portion of operating earnings that goes to interest
TB – Tax Burden: effective tax rate
TATO – Total Asset Turnover: efficiency of resource management / utilization
EM – Equity Multiplier: measure of financial leverage
ROE
OPM IB TB
TATO EM

26. Invested Capital Invested capital is used to acquire assets
The providers of capital (interest bearing debt and equity) expect a return on their investment:
Debt holders (lenders, bond holders) – interest payments
Equity holders – expect a return through dividends and price appreciation
The “blended” rate of return for all providers of capital is called the “Weighted Average Cost of Capital” (WACC).

27. Economic Value Added
Economic Value Added does a better job than net income of showing the true economic performance of a firm over a period of time. It is measured in dollars.
EVA deducts a capital charge to reflect the economic cost of invested capital.
NOPAT = Net operating profit after taxes = EBIT x (1 – T)
WACC – weighted average cost of capital; blended cost of the firm’s capital
Capital Charge ($)

28. Economic Value Added An equivalent way to look at EVA is:
The EVA Spread is the difference between the return earned on capital and the cost of capital. The bigger the difference, the better.
IC($) is the amount capital the company has deployed (invested).
Can see here the operational aspect, the financing aspect and the investing aspect of firm management.
EVA Spread (%)
Go to Bloomberg – WACC analysis – see EVA, ROIC, EVA Spread, look at graphs.

29. Market Value Added
Market value added (MVA) is the difference between the current market value of a firm and the capital contributed by investors.
If MVA is positive, the firm has added value. If it is negative, the firm has destroyed value.

30. Joel Stern from Stern Stewart describing EVA and MVA:

31. Ratio Reminder Liquidity Asset Management Debt Management
Profitability

32. Liquidity Ratios Current Ratio = Current Assets Current Liabilities
Also: Quick Ratio and Cash Ratio

33. Asset Management Ratios
DSO (ACP)
Inventory Turnover
Fixed Asset Turnover
Total Asset Turnover

34. Debt Management Ratios
Debt ratio
Debt-Equity ratio
Equity Multiplier
Times interest earned
Cash coverage ratio

35. Profitability Ratios
Profit margin
Return on Assets
Return on Equity

36. Sources of industry averages
Or….. Create your own

37. Value Drivers
As we will learn in coming sessions, value is determined by the present value of future cash flows.
Value is therefore influenced by anything affecting cash flows or risk
Given what we have learned, that would include:
Net income (sales – expenses)
Asset management
Invested capital
Leverage

38. Financial Analysis Example

39. History
Candlemaker William Procter and soapmaker James Gamble settled in Cincinnati and met when they married sisters
Alexander Norris, their father-in-law, called a meeting in which he persuaded his new sons- in-law to become business partners. In 1837, as a result of the suggestion, Procter & Gamble was created.

40. 1880s, an inexpensive soap that floats in water: Ivory.
1955 first toothpaste to contain fluoride: Crest

41. P&G Brands with sales > $1 billion
Always feminine hygiene products
Ariel laundry detergent
Bounty paper towels
Charmin bathroom tissue and moist towelettes
Crest toothpaste
Dawn dishwashing
Downy fabric softener and dryer sheets
Febreze odor eliminator
Gain laundry detergents, liquid fabric softener, dryer sheets and dish washing liquid
Gillette razors, shaving soap, shaving cream, body wash, shampoo, deodorant and anti-perspirant
Head & Shoulders shampoo
Olay personal and beauty products
Oral-B inter-dental products, such as Oral-B Glide
Pampers disposable diapers. Pampers is P&G’s largest brand
Pantene haircare products
SK-II beauty products
Tide laundry detergents and products
Vicks cough and cold products
Wella hair care products