1. What are some potential problems and limitations of
financial ratio analysis?
2. Explain how the Du Pont system of analysis breaks down
return on assets. Also explain how it breaks down return on
3. Discuss the tradeoff between dividends and growth;
elaborate on the use and limitations of the DividendDiscount model.
1. What are some potential problems and limitations of financial ratio analysis?
Financial ration analysis in the calculation and comparison of ratios which are
derived from the information in a company’s financial statements. Financial ratio
analysis is limited in that it only has the information on the financial
statements. Sometimes financial statements are intentionally inaccurate. The
analysis is based on past performance, it is hampered when accounting policies are
not the same across an industry.
2. Explain how the Du Pont system of analysis breaks down return over assets. Also
explain how it breaks down return on stockholder’s equity.
The Du Pont system breaks down the return over assets (ROA) by analyzing the
separate factors that influence performance, called decomposition.
Profit margin=Net Income/Sales
Asset Turnover = Sales/Total Assets
Return on Assets=Profit Margin x Asset turnover
Return on Equity= Return on Assets/(1-debt/Assets)
3. Discuss the tradeoff between dividends and growth; elaborate on the use and
limitations of the Dividend-Discount model.
When a company chooses to pay dividends this means they have less money for
investment versus just being able to reinvest the dividend. The use of the DDM
method is the find the value of a stock. Under this formula, the value of a stock is
equal to the present value of all future dividends it pays. One of the limitations of
the DDM Model is that one would need to know the future dividends. Furthermore,
it is changed by growth rate and the discount rate.
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