Required: a. For each ratio in the Basic Dupont Model and the Advanced Dupont Model, provide an interpretation, i. e. , are they favorable or unfavorable, is the 5-year trend positive or negative? Note that our reclassifications in 2008 and 2009 do not have an effect on the Dupont ratios. b. Are any of these ratios meaningless because of factors such as negative amounts, denominator close to zero, accounting distortions? c. Are there any factors that make you think the 2008 or 2009 ratio is an aberration and that the future may be significantly different?
Guidance: To determine whether the ratios are favorable or unfavorable, we need to have some benchmarks for comparison, e. g. , prior years’ ratios for the same company, the ratios of similar companies in the same industry, absolute measures such as whether ROE is equal to or greater than the company’s cost of capital, is the company growing as fast as the rest of its industry or the economy as a whole. In addition, we need to keep in mind that the ratios are distorted by any accounting errors that we have not corrected, e. . , if assets have been omitted or are understated on the B. S. , then stockholders’ equity is also understated and this will cause the key performance measures, ROE and ROI, to be overstated. Since our two companies are somewhat unique, we have some difficulty identify peer companies for comparison…to what extent is a comparison of the Netflix to the Blockbuster ratios useful? a) Net Profit margin -The profit margin is a key performance indicator as it extends all the way to th ebottom line of the income statement.
For netflix, its been gradually increasing each year since 2006 and appears to be favroable Total Asset Turnover –This is a good indicator of how the company is managing its sales and purchases of assets. A smaller total worth of assets is favorable as long as its paired with high sales. A higher total asset turnover signifies lower turnover in comparison to sales. For netflix, it decreased in 2007 but is contuing to grow so this is also favorable. Total leverage- This has also indicated small growth over thepast 3-4 years.
It appears to be favorable because its contribuiting to a larger ROE than previous years. Its an indicator of net financial obligations divided by total debt. Having a healthy portion of debt is good for the company to grow and shows to the investor that the company is active in trying to improve profits instead of sitting on cash. Net Borrowing Cost –A low financiaing expense compared to average net financial obligations gives a company more room to for investing activities.
It gives an indication to how the company is managing its obligations and if it can handle additional projects It appears to be favorable for netflix since its decreased the past 2 years Spread –The spread for netflix has nearly doubled since last year and is a good indicator that they have more operating margin and a healthy sales/asset turnover in order for investing activities or handing back a dividend Financial leverage-Leverage is a good indicator of credit risk, especially the risk of defaluting on loans etc.
For netflix, It appears to have increased slightly but this is explainable because netflix needs to invest in more technological savvy delivery methods to its customers. b) None of these ratios appear to be meaningless because of distortions. The possibility exists if sales were inflated or net operating assets were based on historical cost which is a cause for concern. It would be ideal to have theses ratios for the past 4-5 years instead of 2 which exist in the Eval
C) I think financial leverage will be more in the future, because Netflix will eventually have to invest more money into technology for delivery methods, Its not like investing in a machine with a life of 30 years. Technology will be obsolete tomorrow, So I expect this ratio to be anywhere from 10-20% higher next year. Netflix is doing this to stay ahead in the market, so I do not personally think its risky.
