3.1 Use the information in the following table to calculate the following ratios

Question

3.1     Use the information in the following table to calculate the following ratios. Use the results to discuss and compare the financial positions of the two firms.

Ratios:
Total Shareholder Return
Return on Sales
Return on Assets
Return on Equity
Asset Turnover
Times Interest Earned
Debt Ratio (You’ll need to calculate the average debt during the year.)

                                                                          Spaling          Preston

EBIT (Earnings before Interest and Taxes)             300,000         190,000

Interest Expense                                                   10,000           15,000

Net income                                                         200,000         100,000

Dividend payout ratio                                                35%              40%

Retention ratio                                                         65%              60%

Sales                                                              3,000,000      2,000,000

Average assets during the year                          2,500,000      1,500,000

Average shareholders’ equity during the year       1,800,000      1,000,000

Market price per share                                                                        

Beginning of year                                                        20                 18

End of year                                                                 15                 20

Number of shares outstanding                              150,000           50,000

3.2 Assume you have put $1,000 in a savings account at 10% annually compounded interest.

a.   How much could you take out each year and still have the original $1,000 in the account?

  b.   If you left half of the interest earnings in the account, at what rate would the balance grow from year to year?

   c.   If you took out 80% of the interest earnings in the account, at what rate would the balance grow each year?

3.3   Imagine a corporation with $1,000,000 of assets and a debt ratio of 40%. ROE (return on equity) is expected to be 20% for the foreseeable future. Assume the firm keeps the same amount of debt indefinitely (as opposed to keeping the same debt ratio).

a. What do you expect the firm’s earnings to be for the next 3 years if the firm doesn’t pay out any dividends or re-purchase any shares?

b. If the firm doesn’t pay any dividends or re-purchase any shares, at what rate would the firm grow from year to year?

c. If the firm pays 50% of its earnings as dividends, at what rate would the firm grow from year to year?

d. If the firm uses 80% of its earnings to re-purchase shares from its shareholders, at what rate would the firm grow from year to year?

e. If the firm pays 50% of its earnings as dividends, and uses an additional 20% of its earnings to re-purchase shares from its shareholders, at what rate would the firm grow from year to year?

f. What does the term “Sustainable Growth Rate” mean? Would the amounts you have calculated in parts b. to d. equal the Sustainable Growth Rate for the firm?

Explanation / Answer

3.1 a)Total shareholder return= (ending stock price- begining stock price)+ dividends received

Spaling= 15-20 + 0.47 = - $ 4.53

Preston= 20- 18+ 0.8= $ 2.8

b) Return on sales= (EBIT/ sales)*100

spaling= (300,000/3,000,000)*100 = 10 %

preston= (190,000/2,000,000)*100 = 9.5 %

c) Return on assets= Annual net income/ average total assets

spaling= 200,000/ 25,00,000 = 8 %

preston= 100,000/ 15,00,000 = 6.67 %

d) Return on equity = Net income/ shareholders' equity

spaling= 200,000/ 1,800,000= 0.11

preston= 100,000/ 1,000,000 = 0.1

e) Asset turnover= net sales/ average total assets

spaling= 3,000,000/ 2,500,000= 1.2

preston= 2,000,000/ 1,500,000= 1.33

f) Times interest earned= EBIT/ interest expense

spaling= 300,000/ 10,000= 30 Times

preston= 190,000/ 15,000= 12.67 Times

g) Debt Ratio = total liabilities/ total assets

spaling= 570,000/ 2,500,000= 0.228

preston= 440,000/ 1,500,000= 0.293

3.2 a) If interest taken every year then it would be $ 100 every year.

b) Growth rate= .10*.50= 5%

c) Growth rate= .10*.20= 2 %

3.3 a) Return on equity 1st year= 20 % of 600,000 = 120,000

2nd year= 20% of 720,000 = 144,000

3rd year= 20 % of 864,000= 172,800

b) The firm would griow at the constant rate i.e. 20 %

c) The company's growth rate= ROE*retention ratio= .20*.50 = .1= 10 %

d) growth rate= .20 *.80= 16 %

e) growth rate= .70 *.20= 14 %

f) The sustainable growth rate represents how quickly a company can expand using only its own sources of funding.

SG rate= ROE* (1- dividend payout ratio), yes it would same as in b to d.

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