Due: Oct. 12, 2010
Assignment 5-A: DuPont Model Analysis for Netflix
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?
Basic DuPont Model
Net Profit Margin: Favorable. The trend is positive. Net profit margin has increased four out of the five years. This means that the company is making more income per each dollar of sales, which is a good trend.
Total Asset Turnover: Favorable. Total asset turnover has also increased the majority of the time. It slightly decreased one year and increased in the remaining three. Firms would like to have a high margin and a high turnover, so it is a mostly positive trend that turnover is increasing as well as the net profit margin.
Total Leverage: Unfavorable. The trend is positive because total leverage has increased most years. The higher number, the more debt a company has which means that the company has to pay a higher interest expense. Therefore, the net income will be lower which will in turn lower the net profit margin, affecting the ROA. Stockholders want ROE to increase, but not strictly due to the leverage increase. From 2008 to 2009 the total leverage of Netflix increased 1.5 times from 1.569 to .424.
The 5-year trend is positive because ROE has increased each year. It was .153 in 2006 and reached .424 in 2009. It is favorable because it is what investors like to see, but should be looked at closely. The leverage increased greatly over the past year, which is something to keep a close look at.
Advanced DuPont Model
Net Operating Margin: Favorable. The 5 year trend is positive. NOM decreased from the first year to the second, but has increased since then.
Net Operating Asset Turnover: Favorable. This trend is also positive for the most
part. Out of the four years of data, the ratio decreased in one year. The higher
NOM and NOAT, then the higher Return on Net Operating Assets. This is gives
the company a higher ROE.
Return on Net Operating Assets (RNOA): Favorable. This is a positive 5-year
trend. Even though NOAT decreased in one year, the RNOA slightly increased
because the net operating margin increased as well. If the RNOA increases then
the ROE will increase as well which is favorable for the company and
Net Borrowing Cost (NBC): There is only 2 years of data for NBC but it did
decrease (negative) from .079 to .028. This is a favorable trend because the cost
to borrow money is decreasing. NBC takes the firm’s level of debt, the interest
rate it borrows at, or the tax shield that the interest creates into account.
Spread (RNOA-NBC): This number is simply the NBC subtracted from the
RNOA. Data is only available for two years; however, it did increase so it was a
positive change. As long as the spread increases it is favorable to the company.
Financial Leverage (LEV): The LEV has increased over the four years of actual
data that is given. The first two years the LEV was 0, in year 3 it was .05 and in
year 4 it was .507. This has been a positive trend. Leverage is defined different
in the advanced model. Leverage only includes financial obligations in the
numerator. It is favorable that LEV has increased from 0 because it does increase
the ROE; however, it is important that the company does not borrow more than it
b. Are any of these ratios meaningless because of factors such as negative amounts, denominator close to zero, accounting distortions?
There are several ratios that are meaningless. In the Advanced DuPont model the Net Borrowing Cost, the Spread, and the ROE are all not available for 2006 and 2007. This not because the cell is simply empty but because the denominators are close to zero. The cell content looks like this: #DIV/0!. Also, the Financial...
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